The Debt Crisis Is Dead, Long Live the Debt Crisis

Dear SlingShot Trader Subscriber,

Yesterday’s hope for a combined, larger European bailout fund was crushed today by downbeat news from Germany. Stocks were up on the good news, then back down at the open today. Teasing the market like this for too long is never a good thing. Remember the U.S. debt-ceiling crisis in July and August? That didn’t turn out so well for stocks or commodities.

We expect the back-and-forth trading to continue through the end of this week as traders try to forecast the results (or lack thereof) from Friday’s European economic summit. The summit’s purpose is to move forward on long-term agreements for budgeting, treaty modifications and bailouts. It’s not the first summit we’ve seen come and go over the past two years, and we aren’t optimistic that we’ll see any concrete results.

The last summit meeting Oct. 23 led to an initial rally in stocks that you can see highlighted in the chart below. The optimism was based on the “understanding” that leaders had reached a solution for the bailout and would be willing to intervene in the market with a major initiative. The problem was that they revealed no details — only promising to provide more information soon.

Needless to say the details didn’t come later either, nothing material was implemented, and a few days later, a trifecta of bad news (Chinese economic decline, MF Global bankruptcy, Bank of Japan yen intervention) triggered a Halloween sell-off. This is a miniature example of the risks of making promises to the market following a summit and then not delivering anything meaningful.

Without getting too wonky, it’s important to realize that the real issue is political and therefore probably unsolvable in the short term. The funding countries want to impose greater economic restrictions on the countries that need the bailout. Politically, these kinds of compromises leave everyone unhappy and are very difficult to complete. For example, you can see how the Halloween sell-off really gathered some momentum after the Greek government decided to put the terms of the bailout to a referendum vote.

Chart courtesy of Metastock

 

This is an interesting walk down memory lane, but is Europe doomed to repeat October’s mistakes again? We think the risk for that is very high, and we should be prepared to profit from a potential disruption. Prices have rallied recently on Fed intervention, including new favorable swap agreements, but the United States can’t substitute for a true agreement in Europe. We believe this latest move up in stock prices is at risk here at resistance, and a fall could be triggered by another “fluff” summit on Friday.

 

Is All the News This Bad?

Bear markets often are characterized by conflicting information. It increases trading ranges, volume is unsteady, and implied volatility levels become unusually high. However, all previous bearish trends change eventually — and usually at the point of maximum pessimism. As a general rule, we always keep one eye peeled for bullish opportunities even in a bear market.

Fund flows have been very promising lately. We can track whether investors are moving into or out of the largest stock funds in the market, and that can tell us a little about investor sentiment. For example, in the last three trading sessions, the largest stock fund in the world — the SPDR S&P 500 ETF (SPY) — has attracted $5.97 billion in new inflows. This continues a trend that has been moderately positive for a while.

Earnings reports for the third quarter have been trailing off for a few weeks, but the average results have been surprisingly positive. If we exclude financial stocks, 70% of the S&P 500 surprised analysts with better profits this quarter. That’s within a percentage point of the performance we saw in the third quarter of 2010, just as the market was embarking on a very robust trend-extension.

Despite the good news, stocks have remained channel-bound because the uncertainty from Europe is dominant and looks too much like the crisis of 2007/2008. This is preventing traders from focusing on the good news and starting to move money into stocks again. This is typical in a bear market when the news can seem very contradictory and confusing. Uncertainty about the future is very destructive for stock prices.

 

This Week’s Events

Earnings are still quiet while we wait for the year-end reports in January and February. However, there are some very important news events that we’re watching and trading in the short term. The most important of these are listed below. We’ll discuss these in more detail during our weekly webinar today at 6 p.m. ET.

  • 12/8 — Costco (COST) first-quarter earnings — before market open
  • 12/8 — Smithfield Foods (SFD) second-quarter earnings — before market open
  • 12/9 — European Union Economic Summit — all day
  • 12/13 — U.S. monthly retail sales — 8:30 a.m. ET
  • 12/13 — FOMC interest rate statement — 2:15 p.m. ET
  • 12/13 — Best Buy (BBY) third-quarter earnings — before market open

 

The Bottom Line for the Next Seven Days

Without a lot of earnings reports or other economic data due to be released this week, traders will be hyper-focused on Europe. We feel that risk still is biased to the downside in the short term, but it’s possible for a “Hail Mary pass” over the weekend that could be a game-changer. We’ll remain flexible enough to take advantage of that if it were to occur. This can be a difficult time emotionally for short-term traders, so if you feel a little uneasy, you are not alone.

We’ve been setting up trades lately to take advantage of the Euro-centric uncertainty. Both BAC and GLD are designed to profit as news is released both before and following the summit. However, we would encourage traders to set their expectations that price swings are likely to be quite wide before an actual breakout occurs.

In today’s live webinar, we’ll discuss expectation setting and how that affects position sizing.

 

TRADE REVIEW

When it’s time to open or close a trade, we’ll send you alerts via email. You also can sign up to receive text messages regarding our trades. For more info about our SlingShot Trader portfolio, you can read trade alerts here and view our portfolio here. You also can see more trade-specific details by clicking on the trade links below.

 

Positions Opened

These are the SlingShot Trader positions we opened during the past week of trading and haven’t closed yet.

Costco (COST) On Dec. 5, we bought to open the COST Dec 85 Puts for 99 cents. Earnings will be announced tomorrow morning, and the position is volatile today. Enter the trade today only if you can get in at or below our original entry price.

Bank of America (BAC) On Dec. 1, we bought to open the BAC Dec 5 Puts for 19 cents. The stock has rallied, and the position could be opened for less than our original entry. We still recommend this position although we expect price swings to be wide before a breakout to the downside.

SPDR Gold Trust (GLD) Earlier today, we bought to open the GLD Dec 170/175 bull-call spread for $1.80. Our price limit on this new trade is $2. We’ll discuss this position in more detail during tonight’s live webinar at 6 p.m. ET.

 

Positions Closed

These are the SlingShot Trader positions we closed during the past week of trading.

Lululemon (LULU) On Nov. 29, we ‘bought to open’ the LULU Dec 45 Puts for $1.95, and we ‘sold to close’ them Dec. 1 for $3.10, for a 59% return in three days.

Krispy Kreme Doughnuts (KKD) On Nov. 28, we ‘bought to open’ the KKD Dec 7.50 Calls for 20 cents. We ‘sold to close’ them Nov. 30 at 40 cents, for a 100% return in two days.

 

Top Trades Now

These are the current SlingShot Trader positions that we still recommend getting into now, assuming you haven’t already bought a full position.

Bank of America (BAC) See Positions Opened above.

Costco (COST) See Positions Opened above.

SPDR Gold Trust (GLD) See Positions Opened above.

 

Webinar Preview: Join Us Tonight at 6 p.m. ET

Every Wednesday at 6 p.m. ET, we host our live webinar, in which we’ll review this weekly newsletter, discuss coming events in more detail and walk through our Top Trades. We also encourage you to submit your questions live during the session. We want to do everything we can to help you become a successful options trader, which is why you have live access to us for an hour every week.

And if you have any questions or comments you would like to send us in advance of the live session — or anytime during the week — you can write to us at johnandwade@slingshot-trader.com. (Please send any questions about the status of your subscription directly to Customer Service at service@slingshot-trader.com.)

If you can’t attend the session live, you can watch the archived version on our website in the “Live Weekly” section. It’ll typically be posted within about two hours of the end of the live session.
 

Sincerely,

 

John Jagerson and Wade Hansen
Editors
SlingShot Trader