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« Crisis Investing: Tactics for Today | Main | When Bernanke Says All Is Well, It’s Time to Duck and Cover »
Wednesday
Mar252009

Time To Short The Financials.. Again

In the last few weeks the market has seen an incredible rally, lead by financial stocks being spurred on by various ridiculous statements from both the Federal Reserve and the US Treasury who appear to be intent on pumping yet more money into the system.

However we have not seen a “capitulation bottom” which could be indicative of a turnaround and perhaps the end of this bear market. This recent rally has all the characteristics of a powerful short covering spree, a spree that is coming to an end in our opinion, so we took a short position on US financials in yesterday’s trading session.

Time To Short The Financials.. Again SKF

As for how we have engineered this trade, allow us to explain:

We believe US financials will drop, so this will cause the IYF financial iShares index to fall.
A fall in IYF will result in a rise in SKF of 2% for every 1% that IYF falls, since SKF is a double leveraged inverse financial ETF.

Call options on SKF give us the right to buy SKF shares at a price predetermined in the contract.

This contract offers extensive leverage to the SKF share price, since the price of the calls are moving with the price of SKF by a factor of roughly 2.5 (judging on yesterdays trading).
Therefore we have bought a position in the April 2009 SKF Calls with a strike price of $100 at an average cost of $16.49 as a way of shorting the financials with powerful leverage.

Time To Short The Financials.. Again IYF

As the chart above shows, IYF is sitting on two resistance lines in the 35 area and we expect it to drift down closer to 30. Although the MACD and Relative Strength Index are not incredibly overbought, please note that they haven’t been for at least the last year or so, therefore do not necessarily have to be in the overbought region to indicate that the index is overbought. We believe it is in overbought territory at the moment, with the RSI making new highs.

We placed a sell order for our calls at $24.70, the 50% profit mark, as a default point to sell if the market happens to open severely down. If not we will take each tick as it comes and watch this trade closely, aiming to be out within a week, hopefully less.

If you would like to find out more about our options trading, please click here.

Options trading is not for everyone and this trade contains a good deal of leverage so may not be suitable for all investors.

To stay updated on our market commentary, which gold stocks we are buying and why, please subscribe to The Gold Prices Newsletter, completely FREE of charge. Simply click here and enter your email address

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Reader Comments (5)

SKF looks like a great opportunity. I am looking at either buying the 85/90 call vertical or selling the 90/85 put veridical. Basically it is risk 2 to make 3. If SKF is over 90 on 3/17 I make 3, below 85 I am out 2.

Is there any reason to select the raw option over a combination such as a vertical?

March 25, 2009 | Unregistered CommenterBC

It all really depends on your adversion to risk and how you value the risk/reward dynamics of this trade.

A vertial spread obviously limits your risk more than buying the raw call options, but at the same time you are limiting future potential rewards (profits) from the trade.
The risk in buying the raw call is still limited though, since you can only lose the total amount invested in the calls, but the reward is (in theroy) unlimited since those calls can rise to infinite value.

The reason that we selected the raw option is mainly because the reward is unlimited, especially if we should see another meltdown in financial stocks or some rash move like the nationlisation of banks, a raw call option trade on SKF would really capitalise on this, whereas the vertical spread would have its profits limited at a certain level.

Also remember that if one wanted to lower the risk of the trade, one could just invested a lesser amount of capital into the trade, ie buy 1 call option instead of 10.

Hope this helps, any more questions feel free to post them!

Sam

March 25, 2009 | Unregistered CommenterGold Prices

Sam,

True that raw options have "reward is unlimited", but that is not how you are using them. "We placed a sell order for our calls at $24.70, the 50% profit mark" Your risk is 1.00 for a max 0.50 reward. With the ETF at 97.70, I bought the 90/95 vertical call at 2.20. My risk is 2.20 for max 2.80 reward.

Less risk need not imply less money in play. Either strategy could configure any specific risk xxx for a max reward of yyy.

I don't see either as better or worse, just different. I really like the SKF call.

BC

March 25, 2009 | Unregistered CommenterBC

i've been watching SKF for a long time and have bought it this week as it seems very oversold. it has rarely been below the $100 mark and that seems to be a resistance level for it but now that it has broken that level i think theres a possibility that it may go a bit lower in the short term as long as the "obama bounce" continues. what do you think?
however i still think its a very good buy at this price. since SKF is already leveraged i wonder if you have considered just buying the ETF instead of buying options?

Pete

March 25, 2009 | Unregistered Commenterpeter

BC,

You're right, there's not much in it, both ways give a similar result. Its probably a case of half a dozen of one and six of the other! Perhaps one could argue that buying the raw call makes the trade more simple? But either way is pretty good.

Pete,

We regard this bounce as more of a short covering rally than an Obama bounce, although the government announcements have no doubt helped.
More "good news" coud extend the rally further, but we do not think we have seen "the bottom" as such, because we have not seen a total capitulation.
However, we think this "good news" will be positive for gold as it is likely to be announcements of more money being pumped in, which should push gold to a new all time high. Once this happens, gold will pop up on the wider investment community's radar, drawing further buying.

We did condsider buying just the shares, but we really wanted maximum leverage so calls on the leveraged inverse ETF offered that, as we expected this move to be short lived.

However we saw 20% profit on our screens this morning and took it, selling our calls for 19.90
Please read:
http://www.gold-prices.biz/skf-call-options-sold-for-206-profit-in-23-hours/

We expect the financials to drift lower through the next few trading sessions, but for now we are out. 20% in 23 hours is good enough for this trade!

Thanks alot for your comments,

Sam

March 25, 2009 | Unregistered CommenterGold Prices

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