Saturday, January 21, 2006

To Battle!

I've always believed that my ancestors had Viking blood running through their veins as I often find myself deeply affected by the lore of Rus. So, every time I get knocked down, a strong desire to rise and do battle infuses every inch of my being.

I have to tell you, we were quite wrong last week. Not wrong enough to really get hurt but wrong enough to turn a very healthy 6% return on capital for the last expiration cycle into a paltry 2%. Yes, we're up 2% for Jan cycle (we track our results in expiration cycles, even through our official reporting is on a standard monthly basis) , which is better than most money managers, but 2% is really the low end of things for our standards. The most painful thing isn't making less than we expected, it's making that much less because of one day that happened to be the last one!

However, this needed to happen. And looking back, I am very glad it did:
  1. Days like that remind us of market's frequent vagaries.
  2. Days like that reaffirm our faith in our strategy.
  3. Days like that create excellent opportunity for the near future.
  4. And, best of all, days like that wake up the warrior in all of us.
Lots of traders will take a step back here and let the dust settle. Sounds fine, but our strategy tells us otherwise. This is the time to be aggressive because this is where money can be made with high probability.

Why?

Several reasons:
  1. Lots of fear on the street. VIX is through 14 in massively overbought levels.
  2. Dow, SPX and NDX are down too far too fast.
  3. Dow and SPX are at strong Fib support and "agreement" levels (when reached this fast, the probability of a strong bounce is very favorable).
  4. The whole move was likely affected by expiration (indices plunged through several "worthless" strikes) and is likely to be overdone.
So, while I won't make any predictions as to where the market is going to go in the intermediate term, our fund is betting on a strong bounce early next week. Selling premium (vol) into this and getting long stock (this is the time where our model will condone down averaging) is the strategy of choice and it will take some nerves, but in our view this is the only way to game this situation.

Can the market break much lower? No doubt it can. Because that's how the game is played.

Cheers,
/Dmitry

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