Volatility: Today’s Uninvited Guest
August 29th, 2007 by John BrasherI still think the current “meltdown” is no more than a correction, as I always have. So actually, my stomach is not turning - though many stomachs are. The DOW has gone from over 14,000 to nearly 12,400, back over 13,400 and back down to almost 13,000. The move from the bottom of this swing to the recent high was about 1,000 points. Great events produce great volatility, so the volatility levels now should not be a surprise.
Now here is something interesting: a few weeks ago, in July, many people believed the same thing as me: that a market correction was due and even healthy in order for the bull to run a ways longer. Now, today, my view is the “contrarian” view, as many are now in full bear mode. But what is happening now is typical of asset (really, credit) bubble meltdowns.
No, Virginia, the stock market is not going to be fine. It isn’t. One of the largest credit bubbles in history is bursting, and while I don’t expect a full-blown recession to result, the end of the bull market certainly is approaching. I expect the market to regain the high above 14,000 and move to higher ground… for a while.
Not convinced? Consider these factors:
* Record retreat in housing sales for Q2
* Home prices are falling and are expected to continue to fall
* Car sales are hurting even worse
* We’re not close to the bottom of the subprime damage
* Housing woes will only accelerate unemployment
* Adjustable mortgage resets just in FEB/MAR of 2008 will be greater than in all of 2007
* Credit crunch is moving into other consumer debt categories, not just mortgages
* The credit card default rate is rising
I could go on… and on, and on. Bull markets are based on bull economies, it’s that simple. And the economy is deterioriating and will continue to do so. We’re headed for a “muddle-through” economy in economist John Mauldin’s words, maybe worse.
Why do I think the bull market is not over yet? Simple, the economy yet retains too much strength. Corporate earnings, the real bellwether for the market, so far have remained good, if not stellar. But I think the end is in sight. And the end will come when corporate earnings really start to deteriorate. In fact, the bull market’s end will come before that, since the market always leads the economy - that old insider knowledge at work.
And there is little the FED can do. Though some financial writers recently have been preening over how thoroughly the FED has potential dangers well in hand, it ain’t so. In fact, the FED’s hands are essentially tied. It cannot easily cut the FedFunds rate due to well-justified fears of the recessionary monster lurking in the rubble of the bursting credit bubble. And the FED’s announcement yesterday that it might not cut the FedFunds rate in September caused another sell-off. So the most the Fed will likely do, with inflationary fears genuinely looming, is perhaps cut the discount rate again or open up the “discount window” to borrowers other than hurting banks.
Besides, this is the same FED that in March 2007 didn’t expect the subprime problem to significantly affect the “broader economy.”
For those of you writing covered calls, I sincerely hope that you are buying back the calls when the stock moves down. If the stock is $55 and you write the 55 Call, for example, you should be repurchasing the call when the stock falls a few dollars. By closing the call at a price lower than you sold it, you make a profit. As the stock moves up and down, trade the short calls with it. In fact, some call writers in volatile times like to write ITM calls precisely so that the calls will lose maximum value when the stock pulls back.
Volatility has moved into the spare bedroom; you might as well make a few bucks off it.
August 30th, 2007 at 10:40 pm
John, as usual, your comments are spot on.
I especially agree with writing ITM calls in times such as these. For the past couple of months in fact I’ve been writing either ITM or ATM calls exclusively. I’ve been writing covered calls for about nine years now, and writing ITM or ATM calls when the market is especially volatile has been a strategy developed over time for me. Callwriter.com’s lists and information are organized so well that I can scan the lists very quickly and identify potential candidates. I probably do more research than the average trader, but over the years I’ve found what works for me, and refined it down to a system. I have a worksheet that I’ve developed for my own use that makes doing methodical research flow easily. I’m a huge believer in keeping acccurate records of my research and progression of each position. Over time being able to go over such information really helps narrow down the commonalities of great trades.
The one area where I differ somewhat from the Callwriter U way of thinking is with regard to earnings reports. In some instances, such as when I’m very bullish on a company, I’ll start aquiring a position prior to an earnings announcement. Some times I don’t sell calls right away, which is very different from my normal buy/write trade style. In some cases there will be a huge surge in premium immediately prior to the earnings release, or right after. It isn’t something I do often, as I am a big believer in buy/writes being the best strategy the majority of the time. It worked very well for me with GRMN though. I also recently did do a buy/write with OVTI, even though they were announcing earnings today. With the announcement and raised guideance, and the aftermarket action, it appears that it will work out well. I also held CROX over the last earnings announcement with a good result.
There are still a lot of good covered call possibilities to be found with the help of callwriter.com. In the last two months I’ve been able to average right at 8% monthly. I’m not dooing any LEAPS right now though, and haven’t written anything more than 56 days out for a couple of months. I’m very anxious to see the new lists as it sounds like there will be some additional profit potential to be tapped there. Thanks for the continual improvement, it’s greatly appreciated.