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Saturday, June 20, 2009

Week in Review: Economic Strangles and Cost Basis! (PODCAST)

"First rule of business ... buy cheap and sell dear ..." - Colonel King, King Rat by James Clavell

Each week, I have a "Week in Review". We have a brief review of the markets, and then discuss the conversations and hot topics of the last week.

Yesterday, I talked about the sort of maneouvers that would move me towards the inflation camp. Let's say you're not sold on what I'm talking about, when I mention deflation, and even the possibility of hyper-deflation. What if you came from a "hyper-inflationary" camp? Are you a bit confused? A bit anxious? What if you want to go 'both' ways? Is that possible?


I call it, an 'economic strangle' ...

(Podcast Included. If you're seeing this entry elsewhere and cannot play the podcast? Click this link to go to the exact podcast entry ...)

Click here to download this podcast.

Here's the link to Karl's post I mentioned regarding the dangers of opened-ended over-leverage. It's pretty good.

Here's a picture of the Bond Curve:

Note the different maturities create the curve ...

Peter DID say Gold is going to $2,000 in 2009. You have six months Peter. If you can listen to that video, congratulations. I can't even stand to listen to the guy.

Yes, I know I said I hated to rip on people. But I am calling him out by name, because the strategies he espouses, from my experience, and according to my opinion - will send you to the poor house. If you saw someone selling snake-oil to someone, and you had expertise in that area, say ... you were a doctor, wouldn't you step in and try and help? Wouldn't you speak up?

I'm trying to offer other thoughts that will open peoples eyes. To do what I always try to do - help. When I personally believe someone is being conned? I will step in, call out the person by name (as much as I hate to do that) and point out counter-points.

So again, let's look at the strategy that I mention in the above podcast.
  • $2000 Strike Price option on December contract Gold = Hyperinflation or expanded fear bet (locked leverage potential. Total Risk without exercising the option = $100 per option)
  • FAZ = Deflation bet. Say, buying 25 shares at $5.41 stop gtc. Total cost would be $135.25, plus commissions. (locked leverage)
  • JNJ, PG with DRIP on = stagflation, nothing happens bet, as well as a hyperinflation Peter Schiff scenario bet. (compounding posibilties)
  • $1,000 Stored away = Deflation bet.
Equal weighting, that would cost you around $1,760.00 in today's prices. Heck, if the FAZ does what it did in the past during huge down moves? You could make $3,000 on the FAZ positon alone. Weight those positions however you think the economy will turn. In other words, since I believe that deflation is coming, I'd have more FAZ. And be aware of your cost basis. Be aware that as December approaches? Your option will expire (worthless if you don't cash in on it before December).

The biggest risk I see with such a strategy, is that everything moves sideways. Gold moves sideways or down? The option expires worthless by December. The stock market moves sideways or down? Your FAZ doesn't gain any value, or loses a little bit. But even if the stock market moves sideways? Your JNJ and PG stocks will be accumulating dividends, and thus the size of your position increases. If the dollar falls, or even stays flat? Your $1,000.00 isn't earning you anything. But on the other hand? You still would have $1,000 in emergency savings that you could use.

Even if you believe Peter Schiff's thesis (which I dont), his actual implementation strategy is a disaster. I personally believe it's almost criminal.

Remember, with any such strangling strategy, your timing would have to be just right, and it's all about over-coming your cost basis. That's the downside to a strangle. And don't forget, that there are many more instruments out there than what I mention in this blog entry. For example, DOW Futures 4,500 Puts are going for $175. As with the Gold Calls, the option loses value as time passes.

If you want more information regarding the components of price when it comes to options? Here is a playlist that discusses options, and what makes up the price, and what you have to be aware of.

Just be aware of your cost basis for crying out loud. That's money management 101. It's determining, and controlling your risk.

Edit: Oh, and I want to thank Derek (Ohio1998) for pointing out the FAZ to me. I was originally looking at the SDS, but he's the one that pointed me in the direction of the FAZ. As a triple, it'll take a bit more timing, but I think, is a better tool to use than the SDS.

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Note: This is not an investment or trading recommendation. The losses in trading can be very real, and depending on the investment vehicle, can exceed your initial investment. I am not a licensed trading or investment adviser, or financial planner. But I do have 13 years of experience in trading and investing in these markets. The Challenge accounts are run for the education of other traders who should make their own decisions based off their own research, and tolerance for risk.

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