Mister market is sleeping comfortable tonight knowing he caught the maximum number of investors leaning the wrong way.
The post cliff short squeeze was very powerful and it came on high volume. There were 7.8 billion shares traded with 6.9 billion in up volume. The Nasdaq rallied +3% or +92 points and the Dow gained over 300 points. The Russell 2000 hit an historic high intraday.
On any other day these would be very positive signals but coming after a month of negative cliff headlines it may represent a climax spike. The S&P closed only 3 points below its five year closing high at 1465. That is a very strong resistance level and the ideal spot for a double top high.
I am not predicting the market is going to crash. I simply believe investors have been expecting a resolution to the cliff since the middle of November. The market decline last week was early profit taking and the shorts taking positions to profit from a cliff dive if lawmakers could not come to terms.
Each day last week the coiled spring under the market was tightened and today was the release. These monster short squeezes rarely follow through on the days that follow. That is especially true when the top of the squeeze is strong resistance like the 1465 on the S&P and the historic high on the Russell 2000. Those represent ideal locations for taking profits and initiating new short positions.
I would be thrilled to see the markets take off to new highs but there are serious problems ahead. I believe we have about four weeks of a "normal" market before the worries over the debt ceiling begin to take center stage and the political rhetoric reaches obscene levels.
The debt ceiling debate will heat up in mid February if not before. The president is already taking shots at the republican House and they are returning fire. This will cool in the days ahead because nobody wants to use up all their ammunition before the final battle. Every sound bite today becomes fodder for an opposing argument in the weeks ahead. It is better to save your ammunition now because the eventual battle is going to be bloody.
The ratings agencies are already warning that a failure to take decisive action will endanger the U.S. credit rating. The president is already warning that he plans to raise taxes again in March to help pay for additional spending. The CBO has already warned that the fiscal cliff deal will add $4 trillion to the deficit over the next decade.
Remember the debt ceiling debate in the summer of 2011 and the impact on the market. With the republicans still stinging from their latest high profile loss to the president they are not going to be a pushover in February. If anything they have stiffened their resolve to force significant spending cuts and hold firm on no new taxes. The battle of the decade is just ahead. It will make the fiscal cliff seem like a slumber party.
I recommended we close a lot of plays last week in order to avoid any post cliff volatility. There was nothing to be gained by holding them open any longer and much to be lost if the volatility went against us. We made some nice gains on VMW and ATHN and reduced our outstanding risk.
The short squeeze today pushed the VIX to 14.68, a -18% decline and a three month low. That means put premiums have shrunk to minimal levels and not worth selling unless you take additional risk by selling closer to the money. In fact the only puts worth selling are on the VIX itself. There is a very slim chance it will sink lower and a very good chance it will spike back over 20 when the debt ceiling battle begins.
I am going to recommend an aggressive put position on the VIX to take advantage of the coming legislative war.
I am not adding any other positions today since the spike has a good chance of profit taking. There is always time for another trade.
There is another cliff readers should worry about this week. That is the "subscription cliff." Each year we run an end of year subscription special. With 2012 behind us the EOY special is about to expire as well.
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The regular Option Writer newsletter will be published next Wednesday due to the New Year holiday.
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Current Position Changes
ATHN - Athena Health (Short Put - Closed)
ATHN rallied +$10 over the last two weeks and our short $60 put was almost worthless at 15 cents. Rather than leave the play open and risk fiscal cliff volatility I recommended we close the position.
Closed ATHN Jan $60.00 Put, entry $2.50, exit $.29, +2.21 gain
VMW - VMWare (Short Put - Closed)
VMW had rallied +$5 from when we initiated the position. The short put had declined in value from $2.30 to 50 cents. I would normally like to see it a little lower before pulling the exit trigger but after spiking to $99.55 on the 19th it has given back -$5 to close at $94.86 on 12/26. Any market volatility could see temporary support at $94.50 break. I recommended taking profits on Thursday.
On Wednesday parent EMC warned that fiscal cliff worries had hurt profits and the initial gain faded.
Closed VMW short Jan $85 Put, entry $2.30, exit 0.50, +1.80 gain.
ENR - Energizer (Short Put - Closed)
We were short the Feb $75 put with an entry at $81.96 on ENR. The stock had changed its trend and appeared poised to break support at $79.50. I recommended we close the play for a breakeven.
Unfortunately ENR declined at the open on the 27th and we ended with a 20 cents loss.
Closed short ENR Feb $75 Put, entry $1.45, exit $1.65, -0.20 loss.
SBUX - Starbucks (Short Put - Closed)
Starbucks had been a nightmare position for us. We initiated the long term position back in May and it went against us. We added a long June $55 put that was stopped out on a rebound for a +1.58 gain. We added another protective put position using the Sept $42 put as SBUX was diving but the stock turned around and that put expired worthless.
Shares of SBUX declined to as low as $44 and the primary short put was significantly in the money. We had nursed it until it returned to a breakeven position and I recommended we close it and take our risk off the table. With the retail sales numbers for December looking grim we could see SBUX roll over at this level.
SBUX hit a new three week low on Monday before blasting off in the short squeeze to a six month high.
Closed SBUX short Jan $60 put, entry $6.78, exit $7.00, -22 cent loss.
Closed: Long June $55 put, entry $1.06, exit $2.64, +1.58 gain.
Closed: Long Sept $42 put, entry $1.08, expired, -1.08 loss.
Net position (-.22, +1.58, -1.08 = +.28 gain)
New Short Put Recommendations
New Covered Call Recommendations
New Long Term Recommendations
New Aggressive Recommendations
VIX - Volatility Index (Short Put)
This is an aggressive recommendation simply because I am recommending a put strike that is already in the money. The odds of the VIX moving below 14 are extremely low and the odds of it moving back over 20 in February are extremely high. I personally view the risk in the trade as very low but there is always risk.
Remember, this same battle back in August 2011 saw the VIX spike to more than 45.
I am recommending the March $20 strike, currently $3.50. The February $20 strike actually has a higher premium but it expires just before the legislative battle will reach its peak. I am choosing the March strike to get us past end of February when the battle will be at its peak.
Sell short VIX March $20 Put, currently $3.50, no stop.
VIX Chart - daily
VIX Chart - Weekly
Existing Play Recommendations
Links to original play recommendation
RIG - Transocean (Covered Call)
SBUX - Starbucks (Short Put Spread)
CAB - Cabela's (Short Put)
FLS - FlowServe (Short Put)
PCYC - Pharmacyclics (Short Put)
VMW - VMWare (Short Put)
ATHN - AthenaHealth (Short Put)
DECK - Deckers (Short Put)
WLT - Walter Energy (Covered Call)
ENR - Energizer (Short Put)
There are several different formulas for determining margin requirements for naked put writing. These are normally broker specific and some can require larger margin requirements than others.
Here is the most common margin calculation for naked puts.
100% of the option premium + ((20% of the Underlying Market Value) - (OTM Value))
For simplicity of calculation simply use 20% of the underlying stock price and you will always be safe. ($25 stock * 20% = $5 margin)
Prices Quoted in Newsletter
At Option Investor we have a long-standing policy prohibiting the editors and staff from actually trading the individual recommendations in order to conform to SEC rules concerning trades.
The prices quoted in the newsletter are the end of day prices in most cases.
When discussing fills or stops the prices quoted are the bid/ask at the time the entry trigger or exit stop is hit. This is NOT a price that someone on staff actually got using a live order.
For entry/exit points at the market open the prices quoted will be the opening print. The majority of the time the readers are able to get a better fill than the opening print because of market maker bias at the open.
For trades with an opening qualification the prices quoted will be the bid/ask at the time the qualification was met.
All of these rules normally produce worse prices than an active trader would normally get. Because they are standardized there may be some cases where a price quoted was better than an actual fill. If you received a price that was dramatically different than what was quoted please let us know.