Assume recession, how can we profit in the markets?

[admin]

OK, many who post to these forums clearly expect a recession. Let’s have some group discussion about how we might make money, if that prediction is correct.

I’ll start off the brainstorming. Assume a market decline. What if we buy puts on the NASDAQ? I’m adding a JPEG of a quick analysis I did on buying Jan 2008 QQQQ puts.

If the NASDAQ drops just 10% from today, I’m seeing a net profit potential of about 50% of investment.

I’m quite new to options. Is my analysis correct? What do you people think? Let’s assume a market decline, what is the best way to profit from it?

[lewman]

vrudny, I think it’s a sound strategy. I think it’s sound because I’ve been thinking about doing the same myself 🙂

Judging purely from PEs, nasdaq is also the most expensive compared to SP500 & DJI so naturally I expect it to fall the hardest … that is assuming an upcoming recession and the market is going down blah blah blah.

My current plan is to first determine the maximum loss I’m willing to take then spread the amount across PUT options for all three indices. I haven’t looked very closely but I prefer in-the-money options so in case I’m wrong I may be able to salvage something at the end.

I’m also looking to supplement this strategy with a number of stocks, particularly those related to consumption and finance/banking. Personally I think I might have missed the boat on property and builders.

Having said the above, timing-wise I’m still undecided. You might have been following threads in this blog about the market bounce in a mid-election year which we’re in now. I suspect it might even have started and we’re in the middle of it. I think I may just wait until after the fall before I execute this.

[lewman]

“I’m a bit frustrated that I only make about 50% on Jan 08 puts if the NASDAQ falls 10%. I’m comparing that against simply shorting the index, which would net me 10% under the same condition, only with much less risk.”

I also thought about using shorts but am at least ruling that out for myself. Firstly, I don’t think shorting is better/worse compared to puts. I just see it as different ways to skin a cat. Putting the supposed risk of unlimited loss aside since getting squeezed on QQQQ is highly unlikely, I think put options offer what I call execute-then-take-a-vacation benefit because you know the maximum downside. Besides, what I hate the most is I’m right about the ending but was wrong about the process.

The markets are surprisingly strong at this point meaning collectively we assign a low probability to recession in 2007. Besides, the market’s track record for mid-election year bounces is just too good to ignore. So it seems that the insurance premium paid via the put option is not that bad.

“I think what I’ll do is spend HALF of what I plan to spend on options this week and hold the rest in my back pocket”

I think that’s a good strategy.

And how do you choose amongst the different strikes ? I usually stay away from out-of-the-money options and focus on options that are in-the-money a little bit, and just look at the BEP% to see if it’s reasonable (by gut feel). I wonder if there’s a more scientific way to do it.

[lewman]

There’s already a thread discussing why the stockmarket continued to defy gravity. Most seems to agree that it’s a sucker’s rally. Just wanted to revive this thread to continue our discussion on the best way to profit from stock market decline IF you do believe the recent run-up’s indeed a sucker’s rally and the market will go back down due to whatever reasons. Then it simply means we now have a better entry point than a few months ago for shorts, PUT options etc.

vrudny, sorry to go silent on you. For some reason your last post completely escaped me. I do a similar analysis on options but then i just rely on gut feel and I tell myself if the BEP% is a low single digit then it’s a pretty good deal. It is unscientific though.

[rseiser]

I am with you on the QQQQ Jan 2008 puts. I wrote some on the other thread, if you saw it.

I think your analysis is fairly good. I just want to add, that the Nasdaq might drop 10% earlier than by Jan 2008, and then you could take even higher profit since there is premium left in your option. The premium generally shrinks a lot when the market moves in your direction, so it is not going to be much. But if volatility picks up, premiums could be slightly higher.

Also, even if you don’t want to take profits after a 10% drop, you can still write another option for Jan 2008 for a 20% drop (another 9% drop), at which you would have to take profit then. This second option would give you a credit of roughly about $1.50 (depending on time left and volatility), so if your original put was $3.50, you now can only lose $2.00. But you can also only make your stated return for the 20% drop (+$1.50) and not more.

Anyways, my point is that there are follow-up decisions possible, and the profit situation depends on the time. That’s why people say, for options you need a good timing.

I think ChrisJ wouldn’t short here, but Lance Lewis talked about it on Oct 1st. (http://www.lewiscapital.net)

[lewman]

I just started my short-the-market program by purchasing PUTs on RTH (retail ETF) and DIA (dow jones industrial ETF). Foundamentally I agree recent rally’s of the sucker type but who knows, rallies of this type could last longer than it should be (or what we bears want it to be) so I’m going to layer in my trades to average it out.

I picked RTH because I believe the negative savings rate coupled with end of the HEW game means consumption has to slow at some point. Technically over the past few years it’s been trying to break $100 but never did in a meaningful way. It’s now at around $98/99 and I’m betting history will repeat itself. For DJI, it’s crafted a nice uptrend since a few months back and it’s currently at top of the channel so if I’m wrong it gives me some degree of protection. Was going to do same for SPY as well but it just didn’t hit my price target.

Next time I PUT more will probably be either 1) up trends’ clearly broken on the downside or 2) rally continues after a small dip and I’ll jump in again at top of the trend line.

Happy shorting my friends.

[powayseller]

Eric at iTulip.com made a good post yesterday about why he is shorting the market now. (Thanks, Perry for that tip on how to open a new window.)

He writes, “mostly I try to dump the asset class de jour near–not at–the top of the current bubble cycle and go to cash while looking for the next one to ride. I do take sometimes take some short positions in the transitions, but these are never more than 10% of my portfolio. Two reasons. One, as Jeff points out, hardly anyone gets the timing right to pull it off. Two, if you buy and sell trend changes near the top and near the bottom, you don’t have to.”

[powayseller]

“Dr. Marc Faber says living expenses have been increasing much faster than the core rate and that domestic and global numbers are rigged to the benefit of the powers that be. Plus how high could gold sore? Dr. Doom expects US hyperinflation to bring $10,000 per ounce gold and that could be just the beginning. In fact, American’s could see the gold price climb to $1,000,000 per ounce if the dollar demise follows the pathway of all previous fiat currencies.” – goldseek.com

[(former)FormerSanDiegan]

If we see hyperinflation of the type described, wouldn;t a sound strategy be to borrow as much as one can in today’s dollars and buy hard assets like real estate ?

PS Do you think we are headed this direction (excessive inflation) or the deflationary spiral direction ?

[(former)FormerSanDiegan]

duplicate

[powayseller]

I have no clue about deflation or inflation, but I like to read iTulip and Mish’s Global Economic Trend Analysis and Roubini’s blog. I will keep reading their stuff.

Eric Janszen has an interesting inflation/deflation theory, which he developed a few years ago and recently revised, and its based on what happened in the credit bubble of the Great Depression. The guy is simply briliant. It’s his KaPoom theory, and is worth a read.

[PD]

I can hardly believe the upward movement of homebuilder stocks today! Has everyone lost their mind?

[Anonymous]

I don’t understand today’s homebuiler rally. Home Depot reported worse than expected earnings, DHI reported poor earnings but apparently beat analysts.

Regardless, just another short term upward blip, good shorting opportunity none the less.

For options, I suggest looking into Jan 09 puts in addition to 08. I am not convinced the market will tank by Jan 08, but by 09 for sure.

[The-Shoveler]

Nor_LA-Temcu-SD-Guy

Sure seems like a short squeeze, Did not see anything that said to me, Hey the economy is going up (GDP) 5 to 10 % next year get on board NOW !!!, Just my thoughts but the guy’s in NY hate to lose any money, If you make a buck on WallStreet, It’s a Buck that leaves NY and they hate any bucks leaving NY, Just wait until the boomers decide to cash-in. There will be a lot of K-Marts in the Stock Market on that day in my opinion.

Don’t let them put SS into the Stock market, These guy’s would have a field day !!

[powayseller]

I asked Adam Hamilton at Zeal, what is the best way to buy gold coins, and he suggested internet dealer Franklin Sanders, author of the newsletter “The Money Changer”.

He also wrote that “any local coin dealer is fine as the coins are totally fungible. My favorite internet dealer though is Franklin Sanders. He is a newsletter
writer “The Money Changer” and gold dealer with impeccable honor and integrity. I respect him tremendously.”

[Author]

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