The $200 Billion Bottom

Did the Fed Buy a 2-Week Reprieve?

By Bryan Bottarelli
Wednesday, March 12, 2008 1:16 PM EDT
Wed, 12 Mar 2008 17:16:00 GMT

PLAY: Buy the BG April 100 Calls (BG DT) at or under $4.70, good for the day.

PLAY: Buy the FCX April 105 Calls (FCX DA) at or under $6.10, good for the day.

*PROTECTIVE PUT PLAY: Buy the DIA April 120 Puts (DAW PP) at or under $3.00, good for the day.

Dear Bottarelli Research Member,

The big question today is, “Did the Fed just buy themselves a bottom?”

Most of what I’m hearing today surrounds around the idea that the Fed gave the market a temporary shot of adrenalin. Similar to those popular energy drinks (like Red Bull or Monster), the “buzz” will only last briefly — and then the market will re-join its downside trend. On the surface, this argument makes sense. But I’ve read some rather interesting statistics today that would have smart traders (like us) thinking otherwise.

The data points of this market study involved the largest single-day gains on the S&P 500 compared to recent 52-week lows. Yesterday, for example, the S&P 500 blasted up 3% one day after hitting a new 52-week low on Monday. Over the past 20 years, there have been only five instances when the S&P 500 gained at least 3% the day after setting a new 52-week low. In all five cases, the S&P 500 went on to return an average of +6.7% over the next two weeks.

This is a pretty remarkable statistic — and it paints quite a bullish picture here in the near term. Plus, we have another potential Fed rate cut on March 18th, which could be another reason to spark a rally. As a result, I’d like to slightly overweight the call side of our ledger. As you know, we’re currently holding the APA April 120 Calls (APA DU), which are basically trading right at our entry price of $5.10. Shares of APA hit a new 52-week high before falling back down on the mid-morning oil report, so maintain this position for more upside.

APA

At the same time, our LM April 60 Puts (LM PZ) triggered our $2.40 stop loss on yesterday’s massive market advance. As you know, this position was only $0.20 away from our pre-determined sniper sell level, but then got whip-sawed on the pre-market announcement of the Fed’s $200 billion market stimulus. There really isn’t much we can do about a situation like this — aside from close the trade and move on. Had the Fed acted today (instead of yesterday), I’m convinced we would have easily locked in gains on this position. But no excuses, the position is now closed.

LM

Now, to participate in the carry-over effect of the market’s upside, I’d like to add calls on Bunge (BG – NYSE). As you can see below, shares of BG are oversold, as indicated from the shares dipping underneath the 200-day moving average for the first time in over six months. If the market can rally (as indicated from the statistics I listed above), I would think that shares of BG could put in a strong bounce-back. Therefore, let’s add some April calls to our ledger now.

BG

PLAY: Buy the BG April 100 Calls (BG DT) at or under $4.70, good for the day. Place a sniper sell at $5.70 and a protective stop limit at $2.50.

Also looking strong is Freeport-McMoRan Copper & Gold (FCX – NYSE). As you can see from the chart below, the major copper, gold, and silver producer is putting in a very strong bounce right at the crossing of it’s 50-day and 200-day moving averages. This signals an extended upside move, so let’s also get positioned to ride the upside into April.

FCX

PLAY: Buy the FCX April 105 Calls (FCX DA) at or under $6.10, good for the day. Place a sniper sell at $7.30 and a protective stop limit at 3.90.

To balance out the ledger, I’d also like to take a cheap “protective put” position on the DIA. This position will act solely as insurance against our three upside calls. If everything goes as planned, this position will decrease in value. After all, if this position decreases in value, that means our APA calls, BG calls, and FCX calls are increasing in value! But on the same hand, this position will also offer us a safety net if the Dow sells off. While I don’t think that’ll happen, anything is possible with today’s intra-day volatility. Therefore, let’s go ahead and add a position in DIA puts — corresponding to a failure at the DIA’s upcoming 50-day moving average noted on the chart.

DIA

PROTECTIVE PUT PLAY: Buy the DIA April 120 Puts (DAW PP) at or under $3.00, good for the day. Do not place a sniper sell or a protective stop limit at this time, as I’ll manage this position as market conditions warrant.

As a general management note, buy the same amount of DIA put contracts as you would for the APA, BG, or FCX call plays. So for example, if you bought 5 contracts each on APA, BG, and FCX, play 5 DIA put contracts as well. That way, you’re properly biased 3 to 1 to the upside. And as always…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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