The bear rally that wouldn’t die frolicked once again yesterday, leaving shorts badly bloodied and hanging from the ropes. The Dow Industrials, for one, opened sharply higher on a 100-point gap, then just kept going with only tepid pullbacks along the way. The buying spree had been telegraphed the night before when the E-mini index futures appeared to struggle to reach a minor pullback target off Friday’s highs. Because of this, around 1 a.m. Monday, with the June E-Mini S&Ps trading around 878, we warned subscribers with short positions to brace for more insanity: “Bears would be wise to run for the hills if the futures pop above 897.00 today,” we advised, “since that would turn the hourly chart unambiguously bullish. A subtler bullish signal would occur on the 15-minute chart at 885.00.” Not long afterward, both of these Hidden Pivots gave way, overpowered by short-covering on thin volume.
And here’s more bad news for bears: The short-squeeze appeared likely to continue into Tuesday, since there was a whiff of panicky buying in the closing minutes of the session. On the 15-minute chart, the Dow tacked on about 50 points on the final bar, suggesting that at least a few shorts had thrown in the towel. Ordinarily, a price spike on the final bell implies that the last bear has been wrung out. In this case, however, the spike was not quite steep enough to suggest this was the case. In any event, we took a small bearish position in the call options of FAZ, a trading vehicle that allows one to leverage the downside in the Russell Financial 1000. We bought for a pittance (1.20) some October calls that traded as high as 97.30 (!) just before the bank stocks took off in early March. At the time we initiated our small position on Monday, the underlying vehicle was in a death dive that lopped nearly 20% off the FAZ’s settlement price as of Friday. Our out-of-the-money options ended the day down a mere 14 cents, however, and the bank stocks would need to soar to deepen the loss significantly from this point forward. We view this as unlikely, considering that the financial sector’s unseemly rally has been impelled thus far by the kind of delusional thinking that spawned the South Sea Bubble, goldfish-swallowing and Tulip-o-mania. Under the circumstances, we’ll bet the “Don’t Pass” line and take the odds.
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Its funny you mentioned this about the leveraged ETFs. I was just thinking about this the other day. I think leveraged ETFs should be illegal. Most people just don’t understand the concept of how volatility wrecks the value of such ETFs. Over any twenty year period, it is hard to imagine any leveraged ETF trading at more than 1% of its intial price.
In FAZ’s case even if the banks went back to the lows of March, FAZ would only go back to about 30% of its March price. These instruments are strictly for very short term trading, as they all must approach zero over time.
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You’re right, but sitting on five-month, out-of-the-money calls is never the way we play the game. For instance, with the stock going nowhere, we could easily leg on the Oct-Jun 20 calendar for 1.00, then further reduce our cost by another 0.60 by shorting Jul/Aug/Sep successively. So our worst case is a 0.40 loss, but that could quickly turn to a 0.40-0.60 minimum gain — i.e., a credit on the spread — if the bank stocks turn down within the next 3-5 weeks. RA