Below please find subscribers’ Q&A for the Mad Hedge Fund Trader July 24Global Strategy Webinar broadcast from Zermatt, Switzerland with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!
Q: What are your thoughts on the Freeport McMoRan (FCX) long position here?
A: We could take a profit here. We probably have about 50% of the maximum potential profit, but I want to hang on and go to the max on this because we’re so far in the money. Cash always has a premium ahead on any Fed interest rate decision. But long term, I think the stock could double, and with the earnings report now out of the way, we have room to run.
Q: What can you say about semiconductor stocks?
A: Long term we love them, short term they are too high to chase here. I would wait for any kind of pullback and, better yet, pull back from the other side of the next recession. We’re not seeing an improvement in prices or orders so this is strictly a technical/momentum-driven trade right now.
Q: How do you play the Volatility Index (VIX)?
A: There are numerous ways you can do it; you can buy call options on the (VIX), you can buy futures on the (VIX), or you can buy the iPath Series B S&P 500 VIX Short Term Futures ETN (VXX). We are probably a week away from a nice entry point on the long side here.
Q: Does a languishing U.S. dollar mean emerging market opportunities?
A: It absolutely does. If we really start to get a serious drop in the U.S. dollar (UUP)—like 5-10%—it will be off to the races for commodities, bonds (TLT), emerging stock markets (EEM), emerging bond markets (ELD), emerging currencies (CEW), and gold (GLD). All of your weak dollar plays will be off to the races—that’s why I went straight into bonds, the Aussie (FXA), and copper through Freeport McMoRan (FCX). All of these trades have been profitable.
Q: When should we sell the U.S. dollar?
A: How about now? For any kind of strength in a dollar against the (FXA), (FXE), (FXC) and (FXY), I would be buying any dips on those foreign exchange ETFs. We’re about to enter a six-month – one-year period weakness on the dollar. It could be the easiest trade out there. The only one I would avoid is the British pound (FXB) because of its own special problems with Brexit. You never want to go long the currency of a country that is destroying itself, which is exactly what’s happening with the pound.
Q: Should I start selling pounds?
A: It’s pretty late in the pound game now. We went into Brexit with the pound at $1.65 and got all the way down to $1.20. We’re a little bit above that now at $1.21. If for some reason, you get a surprise pop in the pound, say to $1.25, that’s where I would sell it, but down here, no.
Q: I missed the (FCX) trade—would you get in on the next dip?
A: Yes, we may not get many dips from here because the earnings were out. Today, they were not as bad as expected, and that was keeping a lot of buyers out of the market on (FCX), so any dips you can get, go a dollar out on your strikes and then take it because this thing could double over the medium term. If the trade war with China ends, this thing could make it to the old high of $50.
Q: Is now a good time to refi my home?
A: Yes, because by the time you get the paperwork and approvals and everything else done (that’ll take about 2 months), rates will likely be lower; and in any case you’re looking to refi either a 7/1 ARM or a 15-year fixed, and the rates on those have already dropped quite substantially. I was offered 3.0% for a 15-year fixed loan on my home just the other day.
Q: On trades like (FCX), why not sell short the put spread?
A: It’s really six of one, half dozen of the other. The profit on either one should be about the same. If it isn’t, an options market maker will step in and arbitrage out the difference. That’s something only an algorithm can do these days. I recommend in-the-money call spreads versus shorting sell short vertical bear put credit spreads because for beginners, in-the-money call spreads are much easier to understand.
Q: The Mueller hearings in Congress are today. Is there any potential impact on the market?
A: The market has completely detached itself from Washington—it couldn’t care less about what’s happening there. I don’t think politics have the capacity to affect stock prices. The only possible impact was the prospect of the government shutdown in September. That seems to have been averted in the latest deal between the House and the White House.
Q: What about Amazon (AMZN)?
A: Like the rest of technology, long term I love it, but short term it’s overdue for a small correction. I’m looking for Amazon to go to $3,000 a share—it’s essentially taking over the world. The antitrust threats will go absolutely nowhere; Congress doesn’t even understand what these companies do, let alone know how to break them up. I wouldn’t worry about it.
Q: I just received an email inviting me to buy a new Bitcoin auto trading system that is guaranteed to make me a millionaire in four months. It is being promoted by Nicole Kidman. Do you think I should try it?
A: I wouldn’t touch this with a ten-foot pole. No, wait. I wouldn’t touch this with a 100-foot pole! Whenever a new type of security comes out, these types of “get rich quick” investment scams come out of the woodwork. Cryptocurrency is no different. Nicole Kidman was probably paid $500,000 to make the pitch by a promotor. Or more likely, Nicole Kidman has nothing to do with these people and they just swiped her picture off the Internet. I hear about these things daily. Follow their plan and you are more likely to get completely wiped out than become a millionaire. There are NO get rich quick schemes. There are only get rich slowly strategies, such as following this newsletter. Click here to see the above-mentioned scam which you should avoid at all cost. Gee, do you think Nicole Kidman would be interested in promoting the Mad Hedge Fund Trader?
https://www.madhedgefundtrader.com/wp-content/uploads/2016/07/John-with-Hiking-Poles-e1468528643680.jpg354400Mad Hedge Fund Traderhttps://www.madhedgefundtrader.com/wp-content/uploads/2019/05/cropped-mad-hedge-logo-transparent-192x192_f9578834168ba24df3eb53916a12c882.pngMad Hedge Fund Trader2019-07-26 08:04:042019-07-26 08:59:41July 24 Biweekly Strategy Webinar Q&A
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:
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.
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.
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).
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.
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
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Below please find subscribers’ Q&A for the Mad Hedge Fund Trader May 15 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!
Q: Where are we with Microsoft (MSFT)?
A: I think Microsoft is really trying to bottom here. It’s only giving up $8 from its recent high, that’s why I went long yesterday, and you can be hyper-conservative and only do the June $110-$115 vertical bull call spread like I did. That will bring in a 13.68% profit in 28 trading days, which these days is pretty good. This morning would have been a great entry point for that spread if you couldn’t get it yesterday.
Q: How will tariffs affect Apple (AAPL) when they hit?
A: The price of your iPhone goes up $140—that calculation has already been done. All of Apple’s iPhones are made in China, something like 220 million a year. There’s no way that can be moved, they need a million people for the production of these phones. It took them 20 years to build that facility and production capacity; it would take them 20 years to move it and it couldn’t be done anywhere else in the world. So, that’s why Apple led the charge on the downside and that’s why it will lead the charge to the upside on any trade war resolution.
Q: How bad is the trade war going to get?
A: The market is betting now by only going down 1,400 Dow points it will be resolved on June 28th in Osaka. If that doesn’t happen it could get a lot worse. It could get down to my down 2,250-point target, and if it continues much beyond that, then we’ll get the whole full 4,500 points and be back at December lows. After that, you’re really looking at a global recession, a global depression, and ultimately nearing 18,000 in Dow, the 2016 low.
Q: Will global trade wars force US Treasuries down to around 2.10% on the ten year?
A: Yes. Again, the question is how bad will it get? If we resolve the trade war in six weeks, treasuries will probably double bottom here at around a 2.33% yield. If we go beyond that, then 2.10% is a chip shot and we go into a real live recession. The truth is no one knows anything, and we really don’t have any influence over what happens.
Q: How will equities digest and increase in European tariffs for cars?
A: It would completely demolish the European economy—especially that of Germany (EWG) which has 50% of its economy dependent on exports (primarily cars) and mostly to the U.S. And if we wipe out our biggest customer, Europe, then that would spill over here very quickly. Anybody who sells to Europe—like all the big Tech companies—would get slaughtered in that situation.
Q: Is it time to buy the Volatility Index (VIX)?
A: It’s too late to buy (VIX) now. I don’t want to touch it until we get down to that $12-$13 handle again because the time decay on this is enormous. Time decay is more than 50% a year, so your timing has to be perfect with trading any (VIX) products, whether it’s the (VXX), the (VIX) futures, the (VIX) options, or so on. There are countless people shorting (VIX) here, and they will short it all the way down to $12 again.
Q: What should I do about Boeing at this point?
A: We went long, got out, took our profit and caught this rally up to $400 a share. Then (BA) gave it up and it broke down. It’s a really tempting long here. Along with Apple, Boeing has the largest value of exports to China of any company. They have orders for hundreds of airlines from China, so they are an easy target, especially if there is a ramp up in the intensity of the trade war. That said, something like a June $270-$300 vertical bull call spread is very tempting, especially with elevated volatility up here, so I’m watching that very closely. We’re looking for the recertification of the 737 MAX bounce which could happen in the next few weeks; if that does happen it should rally at least back up to 380.
Q: Are your moving averages simple or exponential?
A: I just use the simple. I find that the simpler a concept is, the more people can understand it, and the more people buy it; that’s why I always try to keep everything simple and leave the algorithms for the computers.
Q: What stocks are insulated from a US/China trade war?
A: None. When the whole market goes risk off, people sell everything. Remember that an overwhelming portion of the market is now indexed with passive investment funds, so they just go straight risk on/risk off. It makes no difference what the fundamentals are, it makes no difference who has a lot of Chinese business or a little—everyone gets hit and everyone will get boosted when the trade war ends. There is no place to hide except cash, which is why I went 100% cash going into this. People seem to forget that cash has option value and having a lot of cash going into one of these situations is actually worth a lot of money in terms of opportunities.
Q: Do you have any thoughts on Uber’s (UBER) bad performance?
A: Yes, the whole sector was wildly overvalued, but no one knew that until they brought it to market and found out the real supply and demand for the issue. The smartest company of the year has to be Lyft (LYFT), which got a nice valuation by doing their issue first and keeping it small. So, they kind of rained on Uber’s parade; at one point, Uber was down 25% from their IPO price. That’s awful.
Q: Is Trump forcing the Fed to drop rates with all this tariff threat?
A: Yes, and if you remember, Trump really ramped up the attacks on the Fed in December. And my bet is at the first sign the trade talks were in trouble, they wanted to lower rates to offset the hit to the U.S. economy. There was no economic reason to suddenly demand huge interest rate cuts last December other than a falling stock market. The tariffs amount to a $72 billion tax increase on the American consumer, felt mostly at the low end, and that is terrible for the economy in that it reduces purchasing power by exactly that much.
Q: Would you buy the dollar as a safe haven trade?
A: No, I would not. The dollar may actually go down some more, especially with the collapse in our interest rates and European interest rates bottoming at negative levels. The best thing in the world in a high-risk environment like this is cash—don’t try to get clever and buy something you think will outperform. You could be disappointed.
Q: Why is healthcare (XLV) behaving so badly?
A: You don’t want to get into political football ahead of an election. That said, they’re already so cheap that any kind of recovery could very well take healthcare up big, especially on an individual company basis. This is a sector where individual stock selection is crucial.
Q: Would you buy deep in the money calls on PayPal (PYPL)?
A: Yes, I would. Wait for a down day. Today we’re up slightly, but if we have a weak afternoon and a weak opening tomorrow morning, that would be a good time to add more longs in technology. PayPal is absolutely at the top of the list, as are names like Adobe (ADBE) and Alphabet (GOOGL).
Q: Should I be buying LEAPS in this environment?
A: No; a LEAP is a one-year long term deep out-of-the-money call spread. That was a great December bottom trade. The people who bought leaps then made huge fortunes. We’re too high here to consider leaps for the main market unless it’s for something that’s just been bombed out, like a Tesla (TSLA) or a Boeing (BA), where you had big drops—then I would look at LEAPS for the super decimated stocks. But the rest of the market is still too high for thinking about leaps. Wait a couple of months and we may get back to those December lows.
Q: What happened to your May 10th bear market call?
A: Actually, it’s kind of looking good. It’s looking in fact like the market topped on May 2nd. If saner heads prevail, the trade war will end (or at least we’ll get a fake agreement) and the market will go to a new high. If not, then that May 10th target forecast I made two years ago IS the final top.
Q: You’re saying today we’re at a bottom?
A: We’re at a bottom for a short-term trade with a June 21st target. That was the expiration date of the options spreads I did this week. Whether this is the final bottom in the whole down move for a longer term, no one has any idea, even if they try to say differently. This is totally dependent on political developments.
Q: What do you have to say about Lockheed Martin (LMT)?
A: This sector usually does well with a wartime background. Expect that to continue for the foreseeable future. But at a certain point, the defense stocks which have had fantastic runs under Trump will start to discount a democratic win in the next election. If that does happen, defense will get slaughtered. I would be using any future strength to sell out of the whole defense area. Peace could be fatal to this sector.
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