Most of you have figured out by now that, while I am never without an opinion, I very rarely recommend specific trades on this site. This is for several reasons, not the least of which is the fact that I don't know any better than anyone else what the future holds, and I've already been responsible for the loss of (at least) millions of dollars over the course of my, and the real number is probably in the tens of millions. These days I sleep well at night secure in the notion that no one else is going to lose their ass because of my often drunken prognostications.
That said, every once in awhile the stars align and a trade stands out as one that appears to have a much better than average chance of working out, and doing so with a substantial profit potential. Know this - I will never recommend a trade that I personally have not taken a position in. The last time I recommended a trade on WSO, it was to buy December GLD 108 Calls at $2 or better (I owned them at $2) on September 23. I sold the calls last Wednesday for $3.05 apiece, or a 53% profit.
I say this not to brag, only to illustrate what a no-brainer the trade was. The only thing necessary for the success of the trade was the continuation of Ben Bernanke's deer-in-the-headlights approach to perverting the U.S. money supply. Gold probably goes much higher, and I probably left money on the table, but I pulled the trigger because I'd achieved the price target I set out to achieve when I entered the trade ($1,100 gold = GLD 108 Calls at a $3+ premium).
The trade I'm about to recommend (and that I entered yesterday) is nowhere near as safe a bet as the GLD trade, in my estimation. However, I feel the profit potential more than offsets the risk, and that the success of the trade is simply a matter of "when" and not "if".
Yesterday, the DJIA closed at 10,227 - well higher than it has any business being, in my humble opinion. I'm not typically a bear (over the course of my career I made a lot more money to the long side than the short), but the fundamentals of this market are a joke. So I put my money where my mouth is.
I bought DXD December 33 Calls for $1 apiece. For those unfamiliar, DXD is an exchange-traded fund that is short the Dow x 2. In other words, if the Dow Jones rises 2% (like it did yesterday), DXD falls by 4%, and vice versa. Now, I have no doubt that the Dow is going to fall, and fall substantially. Frankly, I wouldn't be surprised if the Dow saw 8,000 before it saw 11,000 again. What I'm not sure about is whether or not that will happen in the 38 days before these options expire.
I can see the options doubling pretty easily, though. Here's how: if the Dow drops from here to 9,600, the options are roughly $2 in the money, plus whatever time value is left. Here's the math: a 627 point drop in the Dow is roughly 6.2%. That would increase the value of DXD by 12.4%, or take the price from $31.09 (where it closed yesterday) to $34.95. Safe to say you could off the $33 Calls you paid a buck for at $2 or better, depending on how much time is left.
Obviously, a more substantial move pays a lot better. If the Dow drops to 9,000 before expiration, the options you paid a buck for will be worth around $6 apiece.
So why options? Why not just buy DXD and wait, with no expiration date? This is where it gets a little elementary, so experienced options traders can skip this part as I'm writing it for the guys who aren't as experienced or comfortable with option trading.
Let's say you have $1,000 to invest. You could buy 32 shares of DXD at $31.09 a share. If I'm right about the market dropping, and the Dow drops to 9,600, DXD will be trading around $35 a share. You'd make a profit of $3.91 per share, or $125 profit on the trade. Not bad, but nothing to write home about. If you used that $1,000 to buy 10 December 33 Calls, however, you'd double your money. And that is something to get excited about. If I'm wrong about the timing, you lose everything (unless you sell out for a loss somewhere along the line).
Another very real risk is bucking the trend. We used to have a saying back in the day, "Never try to catch a falling knife." Meaning, if a stock is dropping you don't buy it until it bottoms, even if you believe it should be much higher. The Dow has been in a major up trend, and this trade is a bit like catching a falling knife in reverse. If, however, you believe like I do that the market is way overvalued, and that the necessary correction is going to occur at some point in the next 38 days, come on aboard. The market might even be up today as well, which means you'll get to buy your options cheaper than I did, or you might be able to buy a better strike price.
For those who think I'm completely full of shit, that the good times are here again, and that the Dow is on its way to a million, the opposite of this trade can be achieved by purchasing the DDM December 44 Calls, currently offered at $1.10 apiece with the underlying$42.02. To achieve a double in these options, the Dow needs to reach 10,738 by the third Friday in December. Good luck with that.
Here's hoping we all make a bundle. Sorry for the length of the post.
Perma-Bulls, you may fire at will...