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Smart Money Will Sit Tight for Better Prices

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Sometimes it's better to play your favorite sport than the markets.

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Is the bull run over? Are we on the edge of a plunge? Is the gold mania done? Yesterday's 5% drop in the precious one, together with a sharp drop in the US 30-year Treasury (US1) and – by recent standards – a near "collapse" in equities, has bears dreaming of an end to their state of suspended animation.

Longtime readers know that I'm far more a perma-bear than not, but I'm not completely delusional. So before dumping another chunk of change on tail-risk-type put options, consider the following:
  • Tuesday and Wednesday saw yet another $20 billion of new corporate bond issuance and both investment and high-yield rates continue to drop despite the supply;
  • In all, $37 billion of high-yield bonds came to market in February vs. $23 billion in January;
  • On average, CDS on brokers' subordinated debt dropped 30 basis points last week, and after re-steepening, brokers' CDS curves are holding;
  • 2-year swap rates are back in green light territory at around 25bps, down 7bps in two days;
  • Italian spreads to Bunds are back below 5% and the yield on Italy's 2-year note has dropped from 3% to 1.75% in the past two weeks.
If the thesis for an end to the current grind higher in the equity markets is the resumption of the financial crisis...good luck with that, at least for now.

Equity markets are certainly extended and there are growing negative divergences between different indices. Yesterday the S&P 500 (SPX) registered a Perfected TD Sell Setup, and the Russell 2000 (^RUT) put in a "price-flip" off of a completed TD Sell Countdown. Can we drop 5% a la gold? 10%? Sure, and it would mean little in the scheme of things without meaningful deterioration in the corporate bond market.

If companies can continue borrowing money at 2%, 3%, and 4%, you can rest assured that they'll sit on the other side of a sell-off, keep retiring their own stock, and make their EPS look good. I'm not saying it is right or wrong, wise or stupid, or that it has any bearing on the economics of the company, or the (poor) health of the world's economies. It just is what it is, and the consequence is that stock prices are going to have a tough time going down beyond where companies will let them.

Nor am I suggesting that every three-point drop in the SPX is an across-the-board buying opportunity of a lifetime. For stock prices to continue rising, one must firmly count on companies doing the buying or greater fools lifting your offers.

So what's one to do? Judging by the incredibly shrinking volume, more and more players are simply choosing not to play. I'm somewhat in that camp, having thinned out my sheets to the point where I could take a week off and not care to log in and see what happened. But my bias at this point is to put on position to get me longer at lower prices in names that I'm "hoping" will come back to me.

However, since "hope" is not a viable investment approach, I have no desire to pay up any money for the privilege. Which brings me back to the idea of ratio spreads on put options: buy one put at a certain strike and sell two, three, or more puts at lower strikes to pay for the long position. I'm effectively short between the two strikes, and get long below the lower strike, which is where I'm OK holding my nose and buying within the bigger scheme I described above.

Some ideas for you to ponder should you concur that a market correction is more likely than not in the next 60 days:
  • Acme Packet (APKT): 1x2 Apr 30-27.50 put spread at $0.00 cost; gets me long at $25;
  • Medivation (MDVN): 1x3 Apr 60-55 put spread at $2.00 credit; gets me long at about $52.50;
  • Altisource Portfolio Solution (ASPS): 1x3 Apr 60-55 put spread at $0.00 cost; gets me long at about $52.50. Hat-tip to Doug Kass for twitting this intriguing idea;
An assortment of similar positions in energy names, particularly Denbury Resources (DNR), Gulfport Energy (GPOR) and Swift Energy (SFY).

Cue The Gambler refrain.

Editor's Note: At Minyanville we often argue that markets and stocks are driven by four primary attributes: the fundamentals, the technicals, the structural, and psychology. In this weekly piece, trader Fil Zucchi will attempt to digest these four measures to come to actionable recommendations, but with a couple of twists: Rather than relying on standard technical analysis, he will examine the technicals through the lenses of "DeMark" indicators. And rather than highlighting straight entry and exit points for stocks, he will use options to gain long / short exposure, control risk, and generate cash flow. Investors should note: This column will be written 1-2 days prior to publication, so by the time it appears the prices of the securities mentioned may have changed.
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Positions in MDVN APKT SPX RUT US1
The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

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