An Inconvenient Divergence

Above is the three month comparison of the QQQQ's and the SOXX ****click image for full screen view ****

In the last three months the Semiconductor Index (SOXX) has been hammered while the Nasdaq-100 was flat. That is an unusual correlation. Sure, the SOXX is no longer the growth engine that it once was, but is it now the perfect hedge to Nasdaq-100?

The two major drags on the SOXX were Micron (MU) and Advanced Micro Devices (AMD). Micron is usually a story of dRAM prices and inventories; I don't claim to have a good perspective on either, except buying memory is always getting cheaper. AMD was just flying high two short years ago, with the stock over 40, and Ruiz seemed to have delivered the company out of the shadows of Intel. Finally, faster AMD chips were being accepted by Dell. Then Intel did what they always do to AMD, they dropped their prices and upped their R&D to beat them to the next generation chips.

A questionable acquisition of ATI by AMD also contributed to the valuation collapse. Three months ago AMD was at $13, but recently has been hovering around $7.

Is the whole index, including giants Intel and Applied Materials, destined to be a commoditized set of products which take the sizzle out of the steak? Even maturing companies have a few good moves left in them, like an aging athlete who still shows their stuff periodically.

Early in 2008 I plan to establish a ratio spread with long options on SOXX and relatively fewer short positions on QQQQ.

Oil Services

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With the soaring price of oil, Oil Services remain an interesting place to be in 2008.

The graph above shows the price of the Oil Services Index (OSX) for the last nine-plus years. The price, in green, shows a six-bagger return for those that took the long ride. Even if one would've waited until the late summer of 2004 to catch the wave, a triple-bagger was in store.

The blue line shows the price in relation to the price's 34-day moving average. The wider the range, the more volatility is in the stock price. The volatility has been declining, with the range of the price move remaining within +/- 10% of its moving average.

Combining the fundamental and technical point of view, I would expect the former high prices in the OSX to be revisited as the price of oil breaks the $100 per barrell mark early in 2008. From there, I would expect another price correction, perhaps disconnected to increasing oil prices, and then another long bull run.

I will be building an Option Vertical Spread, selling Out-of-the-Money calls into the next leg up and then buying more At-the-Money calls as the price corrects.

Commodities Can NOT Be Ignored

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The Jim Rogers Commodity Index, started in 1998 at 1000, cracked the 4000-mark at the end of September. The graph shows the new Commodity Bull compared to the 1982 Dow Bull. The Dow cracked 1000 in the fall of 1982. Nine years later, in May 1991, the Dow was just breaking 3000.

The Rogers Commodity Index has an eight year CAGR of 16.2%

Paying for a Bad Call (or Put)

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I took the gamble of getting out of the hedged position on the gold index, GOX, and it went parabolic on me. Today (Friday) it lost a few cents. I believe that it will come under some profit-taking; when I say "it" , I really mean the gold shares that the index represent.

I still show a profit of $1700. The one thing that does concern me is the weak dollar, as the US Dollar index fell below 80 today. Technically there's no support below 80. A weak dollar is generally bullish for gold.

You have to RECOGNIZE a profit

Feeling that the GOX has recovered too far and too fast, I covered my sold puts today, taking a $6,030 profit.

This leaves me with 5 Dec 160 Puts, meaning I'm no longer hedged, and will lose my profits if the GOX continues to rise.

Many option traders would buy and sell their hedged positions simaltaneously. That's just not the way I'm wired. My trading models suggest an 8-day bearish indicator, and I feel the index is tired after its run.

Changing a Profit Curve

I'm making some good paper profits on my GOX spread. I sold the Dec 140 Puts at an opportune time (see prior post).
As the price showed me a profit, instead of recognizing the profit by selling, I started to build a spread; which is a hedged position. Today I increased the short side of the hedge by buying more puts (see ticket to the left). After several years of spread building, I can usually visualize the profit curve that it generates, pretty well. But it always worthwhile to graph it, to quantify the exact tradeoffs.

Below is the profit curve before and after today's trade (click on images for full screen view):




Before the trade I clearly favored a bullish GOX index and after the trade I now favor a bearish one. The reasoning is that the GOX index has climbed from 126 to 141 in quick order, and I anticipate some "back and filling' in the price. At that time I will do some more selling of the Dec 140 put.

The macro factors to keep in mind are that Bernanke will probably have to cut interest rates to save the financial markets. That will put the Fed back on track to do what they do well; that is to destroy the dollar. That makes the case for long-term bullish positions in gold. However these are the December options, so I don't see the need to project that far.

Using an Up Day to Get Short

Today's 200 point up-move (DJIA) is providing a good opportunity to establish some short positions. I believe further deteriation of the financials and mortgage mess, will seize the consumer spending habits. Therefore, I'm shorting the financial ETF, XLF and the retailer JC Penny.



Looking at the JCP one-year chart, all you have to do is imagine that the chart is inverted. If the stock had sold off, then rallied back, there would be many a technician ready to believe the stock has consolidated and is ready for new highs. I'm in the opposite camp looking at a rise and sell-off, now expecting new lows.

Knife handled and all fingers are accounted for

The prior day post detailed my entry into the falling Natural Gas market with an option purchase on UNG. Not only did I not get bloodied from reaching for the falling knife, I immediately started a hedged position today on the strength of a nearly 4% bullish move. The ticket to the left shows that I sold 5 calls at a 39 strike price, five points higher than the calls were bought yesterday (34 strike price).

The table and graph show my hedged position with profit and loss results in a range of +/- 15% from today's closing price on UNG (36.36). The story is not yet written as I will likely make more trades, changing the profit curve over the next few trading days. The intrinsic value of my position shows a loss of $695, and the market pricing of the paired options shows me a paper loss of $80.

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Trying to Catch a Falling Knife

It's a cliche on Wall Street. "Don't try and catch a falling knife." I couldn't resist; even knowing Natural Gas supplies are running ahead of short term demand. I bought calls on UNG on August 27. I will build a spread by selling higher strike price calls. It is customary to buy and sell both sides together as a hedge, but the speculator in me likes the asynchronous action.

A good trade on the GOX (gold index)

I thought the GOX had become very oversold at 126.42 on August 16, so I swallowed hard and sold puts (OptionsXpress ticket copy below). This was a very good trade as the GOX recovered 10 points very quickly giving me a $4,000 paper profit. Instead of recognizing the gain, I built a vertical spread by buying the December 160 puts on August 22 (ticket on the right).



This provides a favorable profit profile as the GOX moves +/-15% from here @ 136.62.