Option Investor
New Plays

The Best Position

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Play Editor's Note: This is a tough spot to be thinking about new plays. The market is crashing to new multi-year lows. The S&P 500 just broke down under its 2002 lows, which many were expecting to hold as support. Now "experts" are predicting the S&P 500 to drop toward the 600 level or lower (albeit not immediately). We're hearing pundits call out for the DJIA to trade under 7,000. Yet this seems like a very dangerous spot to be considering new shorts. We've seen the DJIA deliver 800-point and 900-point rallies in a single day. The VIX is near all-time highs. What do you do?

I think Keene said it best in the MarketMonitor today. Flat is a good position. You don't have to trade this mess. Be patient. Wait for your entry point. It can be extremely frustrating to see multi-hundred points moves in the market and be thinking that you should have caught most of the move. For most people that is a fantasy. Professional traders are getting blown up on a daily basis. At least once a week I hear about another hedge fund being closed. If you can day trade and you have successful experience day trading, then fine. This can be a perfect market for you to scalp significant moves from the market. For the rest of us we need to remain on the defensive.

If you want to be thinking about an entry point I would be watching for another sharp move down and only then start to consider opening bullish positions. Here's an idea. The Dow Jones Industrial Average (DJIA) 2002 low is about 7200. A bullish trade would be to wait for a dip into the 7,250-7,200 and then look for the bounce. Depending on your risk tolerance, use a stop loss immediately under the day's low or if you're more aggressive I'd probably put a stop around 6,945. A good way to trade movement in the DJIA is to trade its ETF the Diamonds (symbol:DIA). Buy calls on a dip in the 72.50-72.00 zone, stop loss 69.45. I'd probably target 79.90 or higher. If you don't want to play options but still want to see some movement, then if the DJIA hits 7250 buy the 2x ultra-long ETF the DDM. It will move twice the performance of the DJIA.

Another idea might be the Russell 2000 index. The RUT's 2002 low is about 325 but it bounced more than once near the 350 level. I would consider buying calls on the IWM in the 36.00-35.00 zone with a stop loss at $34.45. My target would be $42.50-44.00. If you don't want to buy call options then consider buying the UWM double-long (2x) Russell ETF, which moves twice the movement of the RUT.

I want to repeat at this point the best move may be to just step aside and wait for the dust to settle. There will always be another entry point.

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