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Time for a Ratio Trade?


What to do if you're too scared to buy, sell, or short.


I'm okay getting grouped with the crowd that believes a bottoming of the financial crisis won't resolve our very deep economic problems; with those who argue that losing only 400,000 jobs per month instead of 600,000 is no reason to go long stocks; with the doom-and-gloomers who suggest that US sovereign debt is going to be treated as the junk that it is sooner rather than later (either because of default or currency debasement); with the Cassandras who suggest that devaluation-based inflation doesn't need tight labor markets to wreak havoc.

The US financial/economic system didn't die on March 6; instead, it was intubated with a 4-foot-wide hose that allowed freshly minted dollars to flow into its system. It was given a makeover to brighten its gaunt, lifeless face. I realize Bernanke can keep the ventilator going for a while -- but in the end, reality will bite.

I've deliberately used cliched metaphors to describe where we stand: Though these problems are well known and accepted, someone has yet to explain to me why they're regarded as being already discounted by the markets -- aside from the mantra that "that's how markets work." For those who believe that, markets haven't discounted one thing for the last 2 years. In fact, they may as well put their picture next to the definition of "reactive."

With that backdrop, the VIX at 25 has me back buying S&P 500 (SPX) LEAPs in scale and in decent size. I hear those who'd rather sell volatility here as the "hard trade is usually the right trade," and I also see the corporate bond market ramping back up like all is good again. I humbly and emphatically disagree.

For those too scared to buy, sell, or short, a ratio trade long the SPX and short the NASDAQ 100 (NDX), is something I've been mulling for quite a while. A recent endorsement of precisely such a strategy by John Roque has nudged me into it, and the position is slowly being grown to a rather respectable size.

As you can tell from this NDX/SPX ratio chart, the current ratio is taunting the probability spectrum. I'm using futures, but it can also be implemented with more defined-risk option strategies.

Meanwhile, my exit from all long-bond-related short positions has saved me a few dollars and far more aggravation. But the 120 level on the 30-year bond (US1) is approaching, and somewhere above that I'll re-enter the ring -- particularly as the 200-DMA turns downward-sloping.

I'll let DeMark counts suggest more refined shorting prices when the time comes.

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No positions in stocks mentioned.
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