Seldom has the confidence of investors been so egregiously misplaced as it is now in junk bonds. The Wall Street Journal of course found reason to celebrate this mass outbreak of stupidity with the front-page headline Junk-Bond Rebound Signals Easing Fear. Will they ever learn? Fortunately, there could be opportunity here for us, since, as the value of junk paper continues to rise, it will become an increasingly juicy short. We attempted this just ahead of last year’s crash in high-yield bonds, but we made the mistake of leveraging the bet with put options. The lesson learned was that the options had been priced to discount disaster. As a result, even though JNK collapsed nearly 25% in a little more than six months, the puts barely budged. Now, with JNK in a dead-cat bounce, and the Wall Street Journal and their ilk trumpeting the rally as a sign of renewed investor confidence, we might look to get short in JNK at very juicy prices. However, instead of buying naked puts, we can significantly reduce our risk by using option spreads comprising mainly out-of-the-money calendars and verticals. The opportunity does not yet appear to be fully ripened, but I will signal when it’s time. Tune to the Rick’s Picks chat room to stay apprised in real time. _______ UPDATE (March 9, 8:46 p.m. ET): It’s impossible to predict how the stock will open tomorrow, but you can short 33.67 on a sell-stop limit, stop 33.74, if c=33.73 of this pattern on the 15-minute chart hasn’t been breached to the upside first: a=33.83 (3/8 at 2:45 p.m.); b=33.58 (3/9 at 11:00 a.m.). This is just a B-grade opportunity, but we can try again later if it fails to trigger._______ UPDATE (March 11, 1:58 a.m.): The stock opened on a gap above our limit, so there was nothing done. Let’s try again, offering 400 shares short at 34.05, stop 34.21. (If you’d prefer to use put options, your goal should be to leg into $1 vertical spreads for ‘even’ or better at the earliest opportunity.) The pattern we’ll be attempting to leverage is clearly visible on the 60-minute chart, where A=33.45 on 3/3 at 10:30 a.m. _______ UPDATE (March 11, 10:53 a.m.): The rabid little sonofabitch opened on a gap above 34.05 — opened at 34.21, actually — negating the trade I’d suggested. JNK is now trading above the 34.29 D target of an even larger pattern calculated by using A= 33.23. This is all to the good, since the more delusional the rally, the juicier the eventual short. Let’s try again, offering 400 shares short at 34.56, stop 34.61. That’s 0.02 below the p2 resistance of this pattern on the hourly chart: A=32.36 on 2/24; B=33.87 on 3/1; C= 33.45. If we get stopped out, which seems likely because of the way JNK gapped through an important midpoint pivot on today’s opening, we’ll try again at D=34.96. That’s about as high as I could see for JNK’s wilding spree, and it would make for a very promising place to get short. Incidentally, a pullback to 34.21 could offer an excellent opportunity to get long ‘mechanically’, since it is the midpoint pivot of the pattern noted above.
