The “Fade Trade”

Add BSC Puts & PBR Calls

By Bryan Bottarelli
Wednesday, December 12, 2007 11:59 AM EST
Wed, 12 Dec 2007 16:59:00 GMT

Dear Bottarelli Research Member,

Let’s be honest. When you have an indecisive and ineffective Fed, like we do now, it does not make for logical market action. For example, today’s early strength, sparked by assurances of liquidity facilitation, appears like nothing more than a band-aid placed over a gushing flesh wound. To my eye, the Fed has indirectly admitted that they acted inappropriately yesterday, and now they’re trying everything they can to right the ship. From a market perspective, this course of action has worked in the morning — but it appears like this strength is a temporary occurrence. After all, the Dow has already trimmed 100 points off its intra-day gain, taking it back below the 50-day moving average, so the upside euphoria is quickly coming to an end. As a result, I think we have the opportunity for a nice “fade trade.”

INDU

In other words, a “fade trade” is a tactic that involved using an extreme market reaction, based off an economic release, to trade in the opposite direction of that initial reaction. And in this case, I’d like to use the morning upside to enter a new put position on Bear Stearns Companies (BSC – NYSE).

BSC

As you can see, despite today’s strong market rally, BSC is still unable to break through its 50-day moving average. And if an emergency Fed announcement can’t muster enough strength to push BSC higher, than I’m not sure anything will. So let’s fade the strength we’re seeing in BSC right now by adding December puts. Here’s the trade:

PLAY: Buy the BSC December 100 Puts (BVD XT) at or under $3.40, good for the day. Current bid/ask spread is $2.95 to $3.10. Place a protective stop limit at $1.40.

At the same time, I’d like to add some international upside exposure and play calls on Petroleo Brasileiro (PBR – NYSE). As you can see from the chart, PBR is in rally mode today thanks to big news out of Rio De Janeiro.

PBR

You see, Petrobras has officially started up a new 180,000 barrel-per-day oil rig — making this the second rig that’s capable of producing this level of production capacity in the past two weeks. This sets a very positive tone for all of 2008, and as a result, PBR should continue to experience strong upside momentum leading into the new year. Let’s play this upward momentum using the January 115 Calls. Here’s the play:

PLAY: Buy the PBR January 115 Calls (PMJ AZ) at or under $6.90, good for the day. Current bid/ask spread is $6.40 to $6.60. Place a protective stop limit at $3.60.

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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