Wrong! Take Two: Cramer's Rewrite of His Staying Too Bearish Column
By James J. Cramer
Greedy bears get slaughtered just as swiftly as greedy bulls in this market. Maybe faster. (A propos of the tough way this
market is trading, I thought I should address the notion that nobody, neither the bulls nor the bears, is making good
money right now because the trends never seem to last more than a couple of days. This piece looks at ways to
protect yourself and profit from the downside.)
Last week, when all heck was breaking loose and it looked like stocks were headed south fast, I surveyed the landscape for
some puts to buy. (If you think the market is going down, you may want to short stocks. When you short a stock, you
sell it and then try to buy it back later at a lower price and pocket the difference.
(Imagine if you had shorted Intel at $95. This week you could have bought it back at $70 and made $25 dollars.
Now, perhaps you were worried that the market could snap back fast, or that you might be shorting a stock that will
get recommended or get squeezed up by other short-sellers anxious to cover. Instead you might have wanted to buy
puts. You could have bought the INTC (Nasdaq:INTC - news) June 100 put for say, 10 points, when the stock was
at $95 and then sell that put for 30 points when the stock was at $70.
(You would make 20 points, instead of 25, but had Intel gone way up instead of way down, you could only lose those
10 points. That's what a put does. It is another form of shorting, except it has a limited amount of risk: the amount
of the put itself. This piece explores the use of puts on the fly to try to hedge and make money in a declining
market, something that is very hard to do. It is much easier to put puts on when it seems foolish, when the market
is rallying.)
I usually have a set list of companies I want to bet against when I think that the world is coming to an end, but I also do some
ad hoc thinking. (At any given time Jeff Berkowitz, my partner, and I, strategize about companies that we think may
not be doing well in a micro or a macro sense. G.M.'s on strike? Short some suppliers to G.M. Boeing cutting
back? Short some of its suppliers. Tech in trouble? Bet against the ASMLF's of the world.
(It is our hit list. You can't wait until the market is going down to produce this list. You will not have enough time to
do homework. But you may also not want to put these shorts on until you think the market is just about to roll over,
because shorting has been a painful game whenever the market is not euphoric, as is the case right now.)
Right about the time when "ugly" defined the tape, (Here's a term I use all of the time. It connotes the action. The
derivation is the ticker tape, which is a compilation of trades and volumes of trades on the New York Stock
Exchange. The ticker that runs along the bottom of the CNBC and Bloomberg pages is also a tape. Learning to
read the tape is an acquired art. It's kind of like watching a baseball game if you have never been to one. Why is
that guy stealing? What's a passed ball. Sacrifice? You have to know the territory and the territory is the tape.)
I spotted two beautiful contracts, the U.S. Airways (NYSE:U - news) June 65 puts (This is a piece of paper that allows
you to capture all of the downside below 65 for U by the third Friday of June.) and the United Technologies
(NYSE:UTX - news) June 90 puts. (This is a piece of paper that allows you to capture all of the downside for UTX
below $90.)
At that time, U.S. Airways was trading for $71. The puts were trading for a buck and change. UTX was hovering around $94,
while the puts were at 7/8. (In other words, these are what is known as out-of-the-money puts. In the money puts
would have been the U June 75 puts and all of the puts above it and the UTX June 100 puts and all of the puts
above that.
(For short-hand we would call the UTX 95 puts the at-the-money puts and the U June 70s, the at the money puts.
This distinction is crucial because when you are buying out-of-the-money puts you are severely limiting your risk
while keeping your reward good, but lessening the chance of that reward occurring.
(At the money puts are more expensive, but they will begin to profit one-for-one with the common rather rapidly. In
the monies, especially deep in the monies, trade basically one for one with the common. As the common goes down
you make money. As it goes up you lose money, in synch with the common.)
What made these puts beautiful to the eyes of this beholder? Not a lot of capital, first of all. If you want quick insurance and
you don't want to make too big a bet against yourself -- as I told you faithful readers I was buying the dip -- these puts make a
ton of sense. Neither would be missed if they went out worthless. That's the key to quick protection. (This issue cuts
basically to whether you are a bull or a bear. Let's say I like the market intermediate term, but short term I think it
stinks out loud.
(Then what I want to do is make sure that I am not crushed short-term. But if I buy the deep in the monies, I am
accepting the logic that this market has no upward bias at all. I am betting that a stock is going to go down. With
these two puts, I am making two statements. I am buying near-term paper, meaning that there is not a lot of time
protection -- these will expire in a few weeks -- and I am looking for protection that will not cause me to lose a lot of
money if the market goes nowhere or switches direction rapidly to the upside.
(Think of it as a deductible. I have to pay for the first couple of points of hurt, but after that these puts kick in. But
I don't have as high a premium as a non-deductible policy. If nothing happens during the year of high-premium
non-deductible, that's expensive. But high deductible, that's livable. It is no different in options.)
Second, both were within five to six points of pay dirt -- acceptable considering that these two stocks have exceptionally high
volatility. (Think volatility, like temperament. These things go up and down in big swings, so it is possible that they
both could fall flat fast!)
Why U? Rumors of an OPEC meeting were roiling the market. Even though I regard OPEC as no more effective than the
League of Nations, I still know that journalists can be counted on to take any statement from Geneva or wherever they are
meeting at total face value. So the airline stocks, leveraged to fuel, would get hit. (This is just a statement of fact. There has
never been an OPEC meeting that wasn't the one that would stop the decline in oil. And it never works. No matter,
everybody believes they will work, especially the journalists, and you always get a spike up. League of Nations,
remember Collective Security and Wilson?)
U has been up a lot, and even though I do not question its fundamentals, these puts looked too good to pass up. (No, I did not
consider that a U pilot saved my life recently when the plane I was in was struck by lightning. I never confuse U,
the stock, with U.S. Airways, the company.)
I didn't question the UTX fundamentals either. But UTX supplies aircraft engines, and anybody who has picked up a paper in
the last six months knows that Boeing (NYSE:BA - news)
is hurting -- so a little guilt by association could take hold at any minute. Anyway, it is a $90 stock, and there are always people
who liquidate high-dollar stocks in any pronounced selloff. That's enough for me to do a trade if the market's looking terrible.
(Here are a bunch of clues about what are good stocks to buy puts on. I like to buy puts on stocks where people
have profits and might want to preserve them. Both of these fit the bill. And I like to buy puts on stocks that a
thesis can be made that they should be sold, even if the fundamentals check out. Sure enough, a week after this
UTX felt compelled to issue a statement saying things are quite good, because no one believed they could be.)
The next day, UTX dropped to $87 and change. I asked Jeff to call some analysts, all of whom said UTX was doing great. So
I immediately rung the register on a triple. Hey, terrific do, considering that the fundamentals did not favor this result. I could
have bought the common and then ridden it up for a nifty trade, too, as UTX rallied quickly to $92. But I wanted the position
off my sheets. (This is a nasty dilemma, a lady or the tiger situation usually. With the put up 3 with a few weeks to
go, I can either buy common stock and hope for a quick reversal, or I can sell the put outright for a great trade. I
went for the triple which was right, in retrospect, but the textbook says it was worth the gamble to the upside.)
But letter U, now that is a different story. I really screwed this one up royally. The very next day after I put the trades on, the
wires were filled with doom and gloom about the OPEC emergency meeting. Thanks press boys! The price cuts got reported
as a new level of discipline for OPEC, and the airlines immediately got hit.
The puts flew up in value to $2 and change as U dropped to $67 and a fraction. Did I sell the puts? No, not me. Did I do the
smart, textbook trade, buying common stock against the puts to play U to the upside when the fraudulent OPEC meeting was
revealed to all? Nah. I was no different from that deer I saw eating the roses this morning when I went to work. I just stared.
Stared and took no action. I could have bought a ton of U against those puts and then had the virtual free shot north as U ran to
$75 in a straight line. I, on the other hand, went for broke. I paid no attention to my own advice that this dip had to be bought
and instead "hoped" that U would keep falling. Now, with one week to go, I have a wasted asset that will do me no good and
an eight-point move on the stock that those puts would have assured.
Now my head juts silently from the wall of the guy who sold me the puts, just another trophy to indecision. (Okay, now a little
more slowly. Most of the time it does not pay to wait until expiration to hold on to puts. Puts "pump" or go up in
value during scares and big selloffs. It is best to sell them when they have that emotional pump in them. Sometimes,
you have to take action and buy common stock against the put even though it does not protect you until it gets to
the "strike."
(In other words, if I had bought U at, say, $67, I would be at risk for everything from $67 to the strike price of $65.
But I would get the reward if the stock flew up. That's exactly what it did. Anything would have been better than
doing nothing. Had I bought common I would have had a great trade. Had I sold the puts I could have made a little
money. My indecision was costly and wiped out the gain on the UTX.)
That's what you get for staying too bearish in an oversold market. (The market on Friday -- yesterday -- again got too
oversold when it was down 100 points and that was the signal that you should cash in on some of your puts or buy
common against them. That's what we did. The question, going into next week, is, are there enough puts out there
due to expire in June that could cause buyers to come in and do trades like I should have done with letter U. If
there are, we are done going down for the time being, barring a wholesale collapse of Japan.)
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