Profit Opportunity #1

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

From someone who has traded from both sides for over 20 yrs, I feel compelled to clarify one thing that is being discussed here. Squeezes are almost impossible for the insiders to pull off on highly liquid stocks like this.

The Squeeze is an insiders play make no mistake about it. As long as the stock you are looking at is trading over a million shares a day, and also has plenty of individual trades, there is nothing to worry about in terms of a squeeze situation.

It is only when the bulk of the shares are in a few hands, that a squeeze takes place. LEND is not likely to be a candidate for anything like that by looking at these aspects of it. Just stay away from shorting stocks either under $10 or with small capitalization, or low volume, and you should be fine.

Just for what it’s worth

Nice trade by the way

[powayseller]

Chris, do you think this would still be a good time to get some puts on homelenders or builders? It’s obvious they are going down, and if a short squeeze is not a concern, then I don’t see a reason to stay out of it. These people posting are all making great money, while I’m at a measly 5% in cash. But then I wonder, if it’s such an obvious purchase, why doesn’t Yamamoto Forecast recommend it? He’s got us in 100% cash. Why haven’t you recommended it – is it because you stay focused more on the bonds?

[Anonymous]

PS, there are multiple reasons that the money managers aren’t advising their clients to go this route, we’ve already covered these a hundered times (i.e. risk, complications, low P/Es, etc.) and I’m sure Chris can expand on them.

However, the key is that the market as a whole does not believe the housing crash is going to be nearly as bad as we believe it will be. If you look at the Put prices for the homebuilders or lenders, they clearly show that the market is betting on them to go down. The difference is the magnitute. I believe that the affect on builders and subprime lenders will be devestating. That is the opportunity.

[anxvariety]

Bought some Sep 35 puts yesterday – wooo hoooo!! I just closed out my position a few minutes ago at +65% but I’m going to try and get back in in a few days because it looks like these things are just getting started!

This is pretty much the ”put your money where your mouth is” bet of the housing pessimist.

PS,
I know you are uneasy about options.. but I believe they are in line with how extreme your views are.. Our views aren’t that far off, but I feel that you might be even more bearish than I.. when I debate with pro-buy people I usually have some concessions of doubt.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

I am not shorting these stocks here due to the valuations. I do not invest on emotions or opinions. I invest or trade based on what my systems tell me to do. These stocks although they technically look terrible, have ratios that are just out of line for what I would short. I do tend to make more money on the short side than the long side, but do it mostly in futures which is much more liquid. The reason for this is prices drop much more quickly than they rise in general. There is no reason to be afraid of the short side in highly liquid stocks.

I am saving my stock money for the fall long trade. I am putting a large chunk on that setup once it is in place. It will be spread across a group of undervalued blue chips at the time of the entry, probably 5 stocks, 20% in each. This trade should take place approx Nov 1 – Nov 15th depending on market conditions at that time. I do not mind being in cash making 5% for several months, knowing that I will likely make 20% or so in a few months, hence getting about a 25% return per year in stocks. Regardless of the stories you hear, very few people do that year in and year out.

The market over time has such a strong up bias, that most of my models to not meet my minimum return criteria to do alot of short stock trades. I require over 90% accuracy and very low drawdowns. Stocks with low price to sales ratios, and low debt will never give you that over time. The testing on shorting these types of stocks does not give good results.

I do not want to try and pick the one exception to an overall trend based on my opinion. I would much rather have a set of outcomes all pointing the same way, then pick the best one of the good ones. Shorting low price to sales stocks is like taking a set of 100 buy trades, where 90 win and 10 lose. Then you focus on the 10 that lose and try to trade it as a short. You may get lucky occasionally, but over time that is a losers game. I would rather focus on the 90 that win and try to pick say the best 40 of that 90 and buy them.

Here is another example. Lumber has a very stong tendency to rally in the fall. If you bought lumber on the 18th trading day of October and held it for 6 days and exited, you would have a winning trades the last 18 consecutive years. Would you rather buy it on that day, or try and find a reason why this year it will fail for the first time in 19 years? The wind is fully at your back in that lumber trade.

It is my opinion though that shorting the RE sector over the next few years on bounces is probably a profitable play. I will do it in the housing futures if the liquidity ever shows up.

I do not in general like the thought of shorting weakness in a momentum type of play like what we have now. The fally stock rally may put some gray hairs on the shorts because they could drag up everything. This rally could be a biggie.

The one guy claims he is making big bucks on that trade so good for him. I am not trying to rain on the parade, this is just my position as to why I am not short them. I also think the housing fallout will be less severe than what some people think. For those who think the big crunch is coming, I do not see any reason why at some point they should not have put positions.

[powayseller]

anxvariety – I will risk a few grand. Can you tell me the list of options and puts you are buying? I won’t do shorts, but will consider the puts. Is there a professional service that gives us a list for homebuilders and retailers to short, sort of like Zeal does for commodities to buy?

[Anonymous]

Homebuilders take your pick: KBH, CTX, LEN, RYL, BZH, BHS, DHI, PHM, HOV, SPF or the XHB ETF.

Subprime lenders: LEND, CFC, NEW

Retailers: LOW, HD

For Puts, I am more conservative in terms of time frame, mostly Jan08 puts and some Jan07 puts. I expect the real estate industry to totally collapse in 07 that’s why I weighed most of my puts towards Jan08. I look for relatively inexpensive puts, $2.00 or lower that are currently way out of the money, looking for BIG gains by Jan08.

For subprime lenders, the puts don’t look as attractive to me because the market has already priced in huge drops. I think shorting the lenders is a GREAT move.

[lewman]

I don’t find shorting stocks that scary as long as you have a stop loss and stick with large caps (large caps coz it would take a lot of capital to move say microsoft so you’re less likely to be caught off guard). And of course you have a stop loss so the theorectical risk of infinite loss becomes … well hopefully just theorectical.

But options are useful too. I think we’ve all been in situations before where you bought a stock, then the stock went down and triggered your stop loss; then the stock turned back up … the issue I have is time value. What’s considered a “cheap” option ? Is there a way to tell ?

I looked at the Jan 07 LEND put options with strike=$35.00
With stock trading at $33.44, the latest ask price for the option was $4.50 (so the intrinsic value is $1.56 and the rest is time value). And to profit, LEND has to go below $30.50 or -8.8% by January.

Is there a standard or convention with which I can judge if the option is priced too expensively ?

And sometimes I see 2 options for the same month & strike. Like LEND has ODQMG.X and QFWMG.X and both have strike=$35.00 for the month of Jan 07. Does anyone know why ?

Cheers, Lewis

[lamoneyguy]

This is looking like a smart move. Well done.

[lewman]

Also add ITB to the list. It’s an ETF that tracks the Dow Jones US home construction index (yahoo symbol is ^DJUSHB).

I think the real estate downturn (plus higher energy cost etc etc) would finally put a stop to the resilient consumer so the next sector to watch (for shorts) would be retail. Compared to the construction sector, retailers have just barely nudged down and I think the worst has yet to come. Any comments here ?

[powayseller]

I just wrote this earlier: the market does not yet know about the recession, so while they have punished homebuilders and lenders due to earnings shortfalls, retailers/restaurants/ leisure and hospitality/ tourism, manufacturers are still spared. Thus, a better opportunity exists.

Think of car dealers (who buys cars in a recession), Home Depot, Lowe’s, carpet stores…anything that consumers buy will be punished next, and by mid-year start shorting manufacturers.

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

The individual stocks and the market as a whole are leading indicators. Keep that in mind in assessing this. Some of the future problems are priced in already, how much is anyone’s guess. There are actually ways of analyzing this on some level but I am not going into that here.

The stock market has already priced in an economic downturn to some degree, or at the very least a slowing. Remember, smarter people than we are run these big institutions. They have a ton of financial backing to research things.

They way they bullshit John Q public for their own gain is another matter, but do not assume the insiders on Wall Street do not see the slowdown coming.

[CA renter]

powayseller said…

“Think of car dealers (who buys cars in a recession), Home Depot, Lowe’s, carpet stores…anything that consumers buy will be punished next, and by mid-year start shorting manufacturers.”
—————–
Be careful on those and check out what’s going on in their respective industries (I know you will). GM & F (which I loosely follow) are down quite a bit already, though GM has rallied a bit over the past year or so. I actually got long (call options) F last week, and I’m a “doom and gloom” bear. Home Depot has already been hammered, although there might still be room to fall. Check out Best Buy, Circuit City, Harley Davidson, Gamestop, Sherwin-Williams, etc. for more possibilities.

Good luck!

[powayseller]

Chris, could you expand on how the large institutional investors “bullshit John Q public for their own gain”? It puzzles me that they have not sold off more of the stocks by now. Also, you are expecting a rally in the fall, just as we are heading into a recession, and the earnings numbers and economics reports coming out around that time will keep getting weaker. Who will buy into the stock market in a scenario like that? If it’s the big guys, then is this rally part of a game too? I know you will play it right, but you (and hopefully some of us here) will gain at the expense of the suckers. Who will end up buying into that rally and losing? John Q Public?

[Chris Johnston]

Chris Johnston
iamafuturestrader.com

In general what I meant by BS John Q Public is the following. Big Wall Street firms get fees by having people’s money invested in funds. This is why the buy and hold strategy they propogate is constantly reinforced. They cite statistics including how much your return would be reduced over time if you happened to miss the X number of largest up days by being on the sidelines trying to time the market.

Here are some stats regarding this bs. For the last 35 yrs the Buy and Hold strategy in the S&P turned $1,000 into $11,000, a 6.7% annual return. If you missed the 5 best performing days, that $1,000 becomes $150, a -5.3% return. So Mr. Wall Street says, “see you cannot time the market.” What they fail to tell you is in the next paragraph.

Here are the numbers on that same $1,000 if you were able to miss the 5 worst performing days during that same period. It becomes $987,000 a 19.3% annual return. (By the way this is from a study conducted by a friend of mine, this is not my research) My numbers however in my study came out very close to these, probably a matter of rounding decimals differently.

What this shows about as clearly as it can be shown is that missing the worst days is far more important than catching the best ones. Timing does matter a great deal. No Wall Street guy is going to tell you that when his income is contingent upon you keeping your funds fully invested.

The insiders all know of the strong bullish cyclical tendency for rallies in mid term presidential congressional election years. This is one of those. We have dropping long term rates the last 45 days, which is helping set up this rally.

Also, remember, a shifting to blue chips by the big institutions is a sign of caution for them. They tend to hold up better during down periods. They have to have their money committed, so that is a shift they make when they anticipate a drop in the market. That happened during March and April, and low and behold look what happened. I had warned in my blog of the bearishness of the Dow ouperforming the S&P. It did this due to what I have just described.

Make no mistake about it, the stock market is an insiders game. So getting in tune with what they are doing is how we as individual investors can make money and beat the market as a whole. The COT report is so helpful in determining what they are doing, and why I reference it so often.

As a trader all I can do is try and stack the odds as heavily in my favor as I can. Once I have done that, I just pull the trigger and stick to the plan. At times I am wrong as you know. I have about an 80% winning percentage as evidenced by my trading service over time. This means that 20% of my trades will be wrong. Maybe this is one of them that will be wrong. I still like the odds and will pull the trigger with a large chunk in the fall if everything sets up properly. I will follow my plan for entry and exit, and then let it play out.

There will probably be one fly in the ointment when it sets up as rarely are things perfect in the markets. If the commercials are heavily long in the fall, and the bonds hold up, the trade will be done. Any questions, send me an email at [email protected].

Last thought – there is a lot of info on the web about mid-term congressional elections and there bullishness for stocks. Do your own research.

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