When I was in my late teens, my father took me aside one day and told me "there's no such thing as a free lunch!" At the time, I had no idea what he was talking about and just nodded my head and went back to doing whatever it was that teenage boys did. Little did I know what valuable advice he had just given me! Crude Oil has been the major story in the markets for the last few weeks and at first glance it would be hard to figure out who would be at risk outside of Russia and a few small time drillers out of North Dakota. But I will tell you who are shaking their heads right now wondering where their free lunch is…the banks. Not too long ago, bankers were falling all over each other to offer cheap financing to anyone who was looking to get in on the US Oil boom. What a great way to profit from a booming market without ever having to drill one hole in the ground! Now, as energy companies start to face liquidity concerns, there is a very real possibility of a credit crunch should oil prices remain depressed. This could very easily cause a self-fulfilling downward spiral as other struggling companies to go into default when these banks rein in lending. I think that at least for the short-term, lower crude prices is good for nearly all involved, but it's always important to identify the risks and trade accordingly. Trade well and follow the trend, not the perma-bull OR perma-bear "experts."
The markets swung down for the session, and some stocks took big hits on the pullback. With the volatile nature of the market conditions, stock prices have swung hard in both directions of late. This is why the focus has been on shorter term plays. The market conditions dictate them to be so. While I do see the upside in the markets, I can easily see the downside also. Short term, there is some weakness in play we have to deal with when we buy stocks these days. Yet you cannot discount a strong rally coming in. Last week was a tale of 2 halves. 1st part of the week we swung down and hard selling. Then we filled that with 2 days of ridiculous buying. Friday was down, but a wash as trading action was much lighter than the previous days. We could see something similar this week. I like the upside more than the downside, but I am hedging myself and looking to play in both directions. The markets conditions are calling for it.
Anyone who has ever tried putting their own hard earned money on the line knows that trading is not an easy proposition. It takes a lot a time to study the material and markets and it involves risk. Risk is part of the game and is necessary to enjoy any sort of reward. But, there is no reason to put on risk at an undue level nor for an undue amount of time. Take for example a signal we are contemplating in Goldman Sachs (GS). GS is reporting earnings before the market open on Friday and is presently trading right at $185. It tends not to move huge on earnings with a two year average of right about 2%. We see that the 180/185/190 iron butterfly is presently trading about $4. This seems like great reward to risk of 4:1. If, on Friday, GS is unchanged at $185 and we sell this iron butterfly we take in the entire $4 of premium. If GS moves below $181 or above $189, the most we can lose is $1. We really want to sell this iron butterfly. Then why no signal today do you ask? Because there is no reason to put ourselves at risk for the next three trading days with very little prospect of higher reward. It is no secret that GS reports earnings Friday before the open and most likely the option prices are where they are going to be for the entire week. So, the price of the iron butterfly will most likely not come down. But, it is entirely possible that something really good or really bad could happen in the broad market or GS may issue some comment leading up to earnings, who knows? So, putting on the signal now is all risk with no reward. We will wait for Thursday afternoon and see where things are. The price of the signal could be a lot higher. It could be a lot lower too, but that's ok. We move on and find the next opportunity and don't look back and don't overexpose ourselves to undue risk.
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