Markets Get No Loving on Valentine’s Day Inflation Massacre

There's a massacre for the markets as we're down 300 points in a massive failure of the strong bounce lines.

Happy Valentine's Day!

There's a massacre for the markets as we're down 300 points in a massive failure of the strong bounce lines which we predicted for you a week ago, which are:

  • Dow (/YM) 24,100 is weak and 24,700 is strong
  • S&P (/ES) 2,610 is weak and 2,670 is strong
  • Nasdaq (/NQ) 6,440 is weak and 6,580 is strong
  • Russell (/TF) 1,480 is weak and 1,510 is strong

We needed to see strong bounces on all 4 indexes taken AND HELD for at least a full day before we could safely say the correction is over (it's not).

Strong inflation numbers are killing us this morning (CPI), keeping the Fed on the table for more tightening. There had been no real news in the past week to change what were obviously overbought conditions 2 weeks ago so there was no logic in racing back to the overbought conditions – though we're still a good 5% below the highs. If you almost had a heart attack last week, this is a good time to consider hedges and a great example can be found from the way we adjusted our Money Talk Portfolio (which we discussed on Feb 1st in our Morning Report) by adding a Nasdaq Ultra-Short (SQQQ) hedge that has gained $5,900 in two weeks, almost exactly offsetting half the damage to the portfolio – as intended. That trade idea was:

SQQQ is the ultra-short Nasdaq ETF that's a 3x inverse of QQQ. So, if the Nasdaq drops 10%, SQQQ goes up 30% (in theory, it's not perfect). I'm going to add the following trade as a hedge and WE EXPECT TO LOSE MONEY ON THIS ONE – it's like life insurance, you pay for it but you hope that, each year, it's a waste of money!
Buy 40 SQQQ Sept $16 calls for $2.80 ($11,200)
Sell 40 SQQQ Sept $23 calls for $1.20 ($4,800)
Sell 5 ALK 2020 $60 puts for $8.20 ($4,100)

That's net $2,300 and $2,620 in margin (from the short puts) to protect our current $36,975 gains and our potential profits – not a large price to pay and, if the Nasdaq drops 10%, then SQQQ (now $16.25) should climb 30% to $21.12 and put the $16 calls $5.12 in the money for $20,480, so we'd be up $18,180 and the max pay-out on the spread is $28,000 so about $26,000 of downside protection – which is half of what we started with!

As of yesterday's close, the Sept $16/23 bull call spread was $3 ($12,000) and the short ALK puts were $7.60 ($3,800) for net $8,200, up $5,900 overall but still $20,000 below it's full potential. Unfortunately, the two long positions we added; General Electric (GE) and Barrick Gold (ABX) are both off to terrible starts – but that mean they are stilll great for new entries. ABX reports tonight and we're hoping to get as much love as Chipotle (CMG) did last night, with a 10% pop this morning. CMG was in our Long-Term Portfolio with the following trade from Jan 2nd (see: "2018 Tuesday – How we will be Building our New $100,000 Portfolios") - the first trade in our new portfolio:

CMG/Streth – It's tricky as sales are up 10% from 2016 but profits ($187M) not even half of what they were in 2015 ($475M) and they are getting, at $292, $8.2Bn for the company so at POTENTIAL profit, it's a very reasonable 17 p/e but, at actual profit, it's a ridiculous 44 that you could never justify for a full-grown chain. How long will it take them to get back to $475M in profit but, even if they do, that really only justifies $300 so I would not be aggressive with them at all, but that's not to say I wouldn't play. You can:
Sell 5 CMG 2020 $270 puts for $35 ($17,500)
Buy 10 CMG 2020 $280 calls for $65 ($65,000)
Sell 10 CMG 2020 $310 calls for $51 ($51,000) That's a net credit of $3,500 on the $30,000 spread so 10x return on cash and TOS says $12,400 in margin – so nice and efficient. Also, since I don't expect them to make any rapid recovery, we can sell 4 March $310 calls for $12 ($4,800) and, if we can collect $4,800 a quarter selling calls, that's another $38,400 while we wait to see if we clear $33,500 on the main spread.
Let's make that the first official trade for the new LTP!

CMG was off to a terrible start, dropping $50 from our entry (which came in a bit better than planned) and, in our Live Member Chat Room, we made the following adjustments.

February 7th, 2018 at 10:38 am | (Unlocked) | Permalink
We have CMG in the LTP and I still like the trade, though you could set it up a bit lower now.
Good thing we sold the short calls – that kept us out of trouble. It's too early to pull the trigger but the $310s we'll buy back and wait for a bounce to sell something else for $5-6,000. If we do that every few months (just 30 days on this one), we'll pick up $20,000 per year as a bonus while we wait to see if we get $30,000 for the spread that was a $10,600 credit to start!
That's the sneaky way the LTP works over time. It's a pretty simple trade with a high probability of success but we can work it into a $70,000 gain off a $10,000 credit over 2 years.
And we only sold 5 puts hitting us for $13,000 in margin. The risk of assignment is $135,000 so 13.5% of our buying power but it's not a realistic risk. What's the chances CMG falls below $200? It's not nothing – look what SVXY just did – but realistically, I look at the risk at 500 x $70 (to $200) for $35,000 vs making maybe $80,000, so well worth it (and then we can roll the puts too!).
February 8th, 2018 at 12:16 pm | (Unlocked) | Permalink
CMG – We're kind of even so let's get more aggressive. We'll buy back the 4 short March $310 calls at $1.40 – not because I think we'll come back but it clears the slot for a sell on the bounce. Now we'll take a proper risk and buy back the 10 short 2020 $310 calls ($38) as they are up $12 ($12,000) and I want to lock it in. We can then roll our 10 long 2020 $280 calls ($50) to 10 long 2020 $260 calls ($58.50) as that's well-worth $8.50.
So now, if CMG goes higher, we'll sell the $310s again for $50 but have a much wider spread that's deeper in the money (and we'll sell more short calls). If CMG goes lower, the $300 calls are $43 and we'd sell them by $40 and we'd be in a $40 spread ($10 wider) at a $20 lower strike for net $6.50 more. That's our worse (not worst) case!

This morning, already, our faith is being rewarded with a quick $30 bounce (good for $30,000 gains!) that will allow us to follow-through with our re-cover. Our net entry was a $10,600 credit (we sold those short calls too) and we bought back the short March $310s for $1.40 ($560) and the short $310 calls for $38,000 ($38) and we spent $8,500 to roll the long $280s lower so net $36,460 for what is now 10 2020 $260 calls that are almost all in the money and the 5 short 2020 $270 puts that are $20 out of the money. So, if we sell the 2020 $350 calls for $36 or more, we're in a $90,000 spread for free and have tons of coverage to sell calls, like 4 April $300s for $10 ($4,000) using 65 of the 702 days we have to sell. That's not bad for one slot in a $500,000 portfolio!

Having good hedges allows us to deploy MORE capital when the market is pulling back – because we have the confidence to know that, if the market stays low or goes lower, the hedges will continue to protect us. The SQQQ hedge above, for example, did pay us $6,000 so far but has another $20,000 to go if SQQQ continues up to $23, which is where it peaked out last week. Knowing we have $20,000 coming to us if the market stays down means we have $20,000 we can use to adjust our positions now – while the market is down. If the market comes back, we will lose our PLANNED insurance bet on the hedges while our improved longs make even more money. That is how you hedge!

Meanwhile, at 8:45 am, we're back at 24,400, 2,635, 6,500 and 1,480 and, since 1,480 is the weak bounce line on the Russell (/TF) Futures and the others are still over their weak bounce lines – we'll watch that line to play /TF long above the line – as long as the other indexes are making progress. The sell-off is probably overdone, we knew inflation would come in hot and the Fed is already tightening at 4 of their 7 remaining meetings this year – they won't go 5 so no changes there. That should easily pay for the class and hotel room in NYC!

However, we could have a bigger correction – as noted above so, if /TF is below 1,480, we would rather short the Nasdaq (/NQ) Futures below the 6,500 line with tight stops above – as it has the farthest to fall.

In any case – be careful out there – it's going to be a crazy day!