On The Eve of Reckoning

Stress Test Results Due Tomorrow

PLAY: Buy the SDS May 59 Puts (SDS QG) at or under $2.75, good for the day. Since this is a hedge play, do not set a stop loss or a sniper sell at this time. I’ll manage this play within your daily trading alerts.

Dear Bottarelli Research Member,

On the eve of the stress test results, Wall Street is still partying like it’s 1999. It was reported today that Bank of America is facing a multi-billion dollar shortfall. Translation: They failed the simple standards outlined in the stress test. As a result, they’ll most likely be forced to convert preferred stock into common stock to raise the capital. But apparently, investors were relieved by Bank of America’s capital position — and the stock continues rallying higher. For anyone buying BAC stock right now, ignorance is truly bliss. Enjoy it while you can.

On the employment front, a survey of private-sector jobs found that April lost another 491,000. But since this number didn’t surpass the 600,000 level that we’ve been accustomed to, it was considered good news.

On the home front, Zillow.com reported today that one in five Americans are now underwater on their mortgages. In other words, they owe more than their house is worth. Specifically, 21.9% of Americans currently have negative equity, which is significantly higher than the 17.6% at the end of Q4 2008 and the 14.3% at the end of Q3 2008. This is proof that the U.S. housing market is not getting better, despite what the mainstream media will lead you to believe. Of all the home transactions in the past 12 months, 20.4% were foreclosures and 11.9% were short sales.

And on an unrelated note, the money situation is so bad in California, that Arnold Schwarzenegger now said that it’s time to consider legalizing marijuana for recreational use — just to get the tax revenues.

Having said all of this, I stand firm in my belief that the markets have not bottomed out. We’re still operating in the heart of one of the most orchestrated market rallies in decades. The big question is, how long can the puppet show last? My “theory” alert from yesterday indicated that the rally in financials was an attempt to push the stocks up so that the banking institutions can dilute their shares to raise capital. Money for nothing. What I failed to mention is that the U.S. government owns a large stake in BAC and Citi stock, so perhaps they’ll take profits just before the dilution process begins? The web of deceit is truly twisted and tangled, my friends.

Looking at the Dow chart, if the Blue Chips re-test their 50-day moving average at the 7,500 level — and find support at this level — then I’d be willing to trade with an upside bias. But that still means we have 1,000 points to fall before facing this test. Therefore, I will continue to bite down and hold all of our downside positions. I recognize that SHM, FAZ, ESI, and SRS have all hit our stop loss prices. If you adhered to these stop prices, this was certainly the safe and smart move. But something is telling me to maintain these plays despite their low values. If the bulls give up their run, the downside can be fast and steep — and we could see dramatic comebacks in short order. Therefore, I’ll continue to follow these plays going forward.

Now, here comes the tricky part. Right now, Washington is dictating the market’s directional moves. That’s clear as day. So, it would not shock me to see tomorrow’s results spun in a way that creates even more upside buying. Heck, they’ve done it successfully for two months, so why stop now?

Therefore, I’d like to hedge our downside plays by adding a position that’ll shoot higher if the market’s rally continues. In a perfect world, the Dow will drop 1,000 points (as it should), our downside plays would all blast higher, and this hedge would lose all of its value. The ending result would be profits in the black. But as you know, this market is far from perfect. Therefore, I’d like to commit a small amount of money to put options on the UltraShort S&P500 ProShares (SDS) just in case the manipulation continues.

If we see a knee-jerk upside move, we’ll be able to lock in a quick profit. Or, if we see the classic “blow off top,” we’ll also take a quick profit — and then let our downside plays carry us forward. Either way, as much as I fundamentally reject the market’s continued upside movement, it makes smart trading sense to hedge our plays by jumping on board Wall Street’s current clown show. On that note, here’s the hedge play…

PLAY: Buy the SDS May 59 Puts (SDS QG) at or under $2.75, good for the day. Since this is a hedge play, do not set a stop loss or a sniper sell at this time. I’ll manage this play within your daily trading alerts.

And as always…

Lock and load!

Sincerely,