Dangerous Territory (Again)

VIX At Sky-High Levels

By Bryan Bottarelli
Thursday, October 16, 2008 11:31 AM EDT
Thu, 16 Oct 2008 15:31:00 GMT

Dear Bottarelli Research Member,

We’re once again entering into dangerous territory. As you can see below, the Dow has officially given up all of Monday’s 970-point gain. We’re now looking at a re-test of Friday’s intra-day low at 7,882. My fear is that if we move below this level, then we could realistically quickly drop below 7,000. That’s more than 50% lower than last October’s high above 14,000. Truly remarkable.

INDU

Now, I call this a “dangerous” situation because we could just as easily spark another major upside advance. After all, mutual funds just experienced their largest cash outflow in decades. Hedge funds are liquidating all of their holdings at a rapid pace. And individual investors are getting awfully close to their breaking points. This all leads up to a massive amount of cash parked on the sidelines. In all honesty, I’d rate the odds of a 900-point up-move versus a 900-point down-move at 50/50 right now.

In the past, we’d use this event to play a straddle (preferably an ultra-short or ultra-long straddle). But as I mentioned earlier, we have October options expiration occurring tomorrow. This means that the November options string is what we’ll want to play. Unfortunately, the price premiums on these November contracts are out of this world. Options that we used to trade for $5.00 are now priced above $13.00. This is a direct result of the CBOE Volatility Index (VIX) trading at record prices (noted below).

VIX

So, when you have a dangerous market combined with uncomfortably-high price premiums, the best course of action is to preserve cash and temporarily stand pat. When a trading situation presents itself that more squarely stacks the odds for success in our favor, you’ll be the first to know. Until then, let’s wait for the next strike. In the meantime, go ahead and lock in profits on your ETR November 70 Puts (ETR WN). Stubborn market makers have once again kept these puts from hitting their $6.40 high of the day, so let’s avoid playing their penny-pinching game. If you haven’t already done so, sell your position for the best available prices now. And as always…

Lock and load!

Sincerely,

Bryan Bottarelli

Bryan Bottarelli
Editor, Bottarelli Research

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