Tuesday, October 10, 2006

Selling Pain

Another one of my infrequent posts comes in what I believe to be an opportune moment currently borne by the waves of the U.S. equity markets.

OK, that wasn't too poetic. In fact, the recent events are anything but - for us, contrarians, that is. However, when pain sets in and then gets worse, my battle-worn senses tell me that opportunity is very near. Just like in all the other times when an urgent need to spit blood prevailed over any other feelings.

So, I hear all this talk about the Dow setting a new high and the "educated" crowd crowing that inflation-adjusted, it is actually down 15%. Hence, the exhuberance is driven by ostensibly "fake" numbers.

Eh, maybe.

However, that's not what makes me an almost net put buyer. I see a few other things from my technically driven astral plane:

1. Put vol on many stocks, especially the leaders like GS has collapsed. In fact it collapsed (as in, below its mean) on many issues and that in itself gives a buyer an edge.

2. I see lots of parabolic rises often ending on higher than normal volume. If you don't know what that means, read one of Jesse Livermore's studies. You'll learn something trivial but also irrefutably true: trends tend to end after a prolonged move accentuated by a rise in volume.

3. I see no long opportunities from a contrarian standpoint. Meaning: if you like chasing things or buying breakouts, there are a plethora of setups. However, consider that one of my core put selling strategies is to sell puts in exactly these situations ... when put vol is high. See number 1.

4. I see nothing going down in a way that would make a value play attractive. I look at the markets all day long and I see waves of things running up. It's like an ocean with a huge tide consisting of waves that try outrun each other. The tide edges higher and higher. We all know what happens to tides.

Ultimately, I am not calling a big top. As a trader I am only good at calling trades and here I am calling a tradable correction.

BTW, having this view I think the best way to exercise it is via buying puts on individual issues (watch the vol) or selling stock if puts aren't available. Selling call verticals right here isn't a bad idea either. For example a GS October call spread (185/190 strikes) will yield 10%. Not bad for two week's worth of work.

Trade 'em up and watch your risk. The best way to make money is to make sure you keep it.

Cheers,
/Dmitry

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