Post Election Recap - Weekly Options Summary

Volatility will likely remain high next week as more companies report earnings and Obama moves forward with his administration appointments. In addition, the looming Nov 15 deadline for hedge fund redemptions may also contribute significantly to the volatility. The economy is not well and that will not change next week. We still believe that the market is at attractive levels, and that this is not the time to move to cash. That said one risk of concern is that the market could move down further on “bad appointments” on the part of the incoming administration. Some of the selections for cabinet positions may be market movers like the choice for the all important Treasury secretary. We hope that Obama is deliberate and insightful with his selections. Oil prices are always a wild card, and we hope the recent declines continue which relieves some pressure on consumers. Another major risk is whether the selling pressure returns that we saw in prior weeks, particularly from the Hedge funds. It could be a very volatile and difficult week if the selling pressure overwhelms the market with the Hedge Fund redemption deadline looming. Investors need to be patient, and perhaps even opportunistic in light of the current volatility. If the market moves strongly in one direction, there may be opportunities to play a bounce, as the market has intraday swings of 5% increasing regularity. A good way to play these short term movements is by trading options on the market indexes. Volatility can be very trying for buy and hold strategies, but it does offer opportunities for short term trading. We are going to look for more short term trading opportunities with the market indexes to take advantage of the high volatility in the market.

As an example, last week we found a good opportunity with put options against the S&P 500 Index (SPX). First we sold to open a December 2008 SPX Put with an exercise price of 875. The market had fallen sharply on Thursday and the option premium ($55) rose significantly as a result. We will pocket the premium regardless of what happens. However, given market volatility and our exposure to downward moves, we also bought a December 2008 SPX Put a little farther out of the money having an exercise price of 850. This purchase completes our spread position and will minimize our risk of loss if the market moves against us. The insurance this position provides cost a premium of $35, a good price as we executed this transaction after the market rallied with a resultant drop in premium over $10. We expect the spread position to make money at expiration as we do not think the market will drop below 875, but if it does we will incur only a small loss. In a separate transaction, we also purchased a long term call option against another market index (SPY). This option expires in December 2009 and carries an exercise price of 100. The option became attractively priced in the sharp downturn that occurred on Thursday. We think the market is overly pessimistic and think that this option can increase considerably in value over the coming months. However, we wanted an option with a longer time to expiration to ensure the market had adequate time to recover. We also completed these transactions using limit orders that when set were significantly better than current prices prior to trade. With the current volatility in the market place today, option prices can fluctuate widely throughout the day and using limit orders can help investors take advantage of significant price swings in their favor. As we mentioned before, we may also consider some tax strategies that involve writing puts and buying calls on certain oversold stocks in our portfolios that allow us to take advantage of tax losses before year end. We are still not quite ready to begin buying straight call options on individual stocks as the short term direction of the stock market is still volatile and difficult to predict. The market is just too fragile and volatile right now, with the 3-6 month outlook very uncertain.

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