It’s Mea Culpa Time.  In my article on November 12^th, titled “When to Value Value”, I made a mistake that I still cannot believe I made.  Even now.  Anyway, first the Good News.

The Good News is that none of the performance numbers listed in the article change.  So the system still remains a meaningful improvement versus buy-and-hold.

Here’s the Bad News: When I noted which price data series was being used when a long position was taken, I somehow got it in my head that it was taking price data from the “Value” column.  It was not.  The price data used during long positions come from the “Growth” Column.

In other words, the article should rightly be titled “When to Value Growth”.  So to be clear (for a change), when the calculated value in question is negative, an investor would hold GROWTH stocks (NOT VALUE stocks).

My thanks to an alert reader who tried to replicate my results and got way different numbers and alerted me to his findings.  After reviewing things I finally realized my error.

I apologize for any inconvenience.

The link to the corrected article:

http://jayonthemarkets.com/2013/11/12/when-to-value-value/

2013 Market Year in Review   

The analysis is actually pretty simple:

Stocks:

Financial, World and Economic News: BAD

Stock Market Performance: GREAT!

Bonds:

Investor A: Hey, have you noticed that t-bond yields have hit a 15 month high? Investor B: What, me worry?

Gold:

Ppppppphhhhhhhhttttttt!

So it is pretty obvious at this point that stocks were the place to be in 2013 (which is maybe why the Investors Intelligence poll registers just 14% bears).   Of course, no one is ever content with that kernel of knowledge.  We want to know what’s going to happen in the future.  In fact the investing public is so hungry for “advance” knowledge that there are now thousands of pundits out there offering all kinds of wildly differing opinions.

So all the investor has to do is decide which opinion they “want to believe”, find a pundit offering that opinion, and “Voila” – they have “expert confirmation” that their opinion is “correct.”

And so it goes, and so it goes.

Meanwhile, back here in reality land, a simple trend-following approach can reap many benefits, especially when the following mantra is true for the stock market:

“If the Fed is pumpin’, the stock market’s jumpin’.”  Period.  End of analysis.

The Right Way and the Wrong Way to Look at Trend Following Methods

There is a right way and a wrong way to look at trend-following indicators:

The Wrong Way: “Wow, my handy dandy trend following indicator is bullish at the moment, therefore I can extrapolate this out to mean that this bullish trend will continue for some time to come.”

The Right Way: “Well, the trend is up at the moment, but of course this could change at any moment, so while I won’t panic and sell everything as long as the trend is still up, I will check back often and if the trend changes I will change my thinking and actions accordingly.”

The most important thing to remember about trend-following indicators is this:

-There is no “prediction” built into the current reading

In other words, a trend-following method does nothing more than identify the current trend right now.  Tomorrow is a different day.  While this may not “sound” as useful as some fancy indicator that portends to be able to predict the future, in reality it is actually much more useful.

Likewise, also remember that there is no humanly possible way to eliminate occasional whipsaws when using moving averages.  So learn to live with it.

Trend-Following Indicators I Have Known and, er, Followed(?)

None of the indicators or methods that I will discuss next will ever pick a bottom or a top.  In fact, they may not even really impress you in any way.  At least not until you find yourself on the sidelines while the market is powering higher without you on board.  So here are a couple of simple trend-following indicators to keep in mind:

The 200-day Moving Average

OK, this one is so basic and so commonly followed that it gets dismissed by some people.  But Figure 1 displays a variety of markets during different time frames.  In fact, an investor who simply fought the urge to fight the trend would have enjoyed riding some nice uptrends (particularly in the stock market) and avoided a lot of pain (most notably in bonds and gold). Figure 1 – Four Markets with 200-day simple moving average  (Courtesy: AIQ TradingExpert)

The Bowtie Pattern

I learned the Bowtie pattern from David Steckler (http://www.etfroundup.com/), who in turn learned it from David Landry (www.davelandry.com).  It involves three moving averages:

-10-day simple moving average

-20-day exponential moving average

-30-day exponential moving average

A Bullish signal occurs when the 10-day is above the 20-day and the 20-day is above the 30-day.

A Bearish signal occurs when the 10-day is below the 20-day and the 20-day is below the 30-day.

As usual, different traders use things in different ways.  David likes to enter as soon as a new trend emerges, I prefer to look for pullbacks within an established trend.  I suggest you explore both possibilities.  Figure 2 – Four Markets with 10-day simple, and 20 and 30-day exponential averages  (Courtesy: AIQ TradingExpert)

The 13-55 Exponential Moving Average

OK, at some point one moving average method looks pretty much like every other moving average method.  In fact that is actually the case.  Linda Bradford Raschke of Market Wizards fame (www.LBRGroup.com) once stated (OK, for the record, I am paraphrasing here)  that “there is no one best moving average method, so just pick something and go with it.”

One more combination that I like as an intermediate term guide is the 13-day and 55-day exponential moving average combination as shown in Figure 3.

 Figure 3 – Four Markets with 13-day and 55-day exponential averages  (Courtesy: AIQ TradingExpert)

Summary

I encourage you to take a closer look at all of the combinations I’ve mentioned above.  Remember two things:

-If you try to use them as Standalone systems (i.e., buying at every bullish signal and selling at every bearish signal) you are likely to be disappointed.

-The real power comes from using methods like the ones I’ve shown to objectively identify the current major trend, and then figuring out ways to trade in line with the major trend.

Jay Kaeppel

In my recent MTA webinar (http://go.mta.org/watch112013), I emphasized the point that there has never been a better time to be a trader.  The number and variety of opportunities available is fairly amazing.  So let’s take a look at another trading opportunity that was not available at all not that long ago.

Here are the Trigger rules:

-VIX Index <=20

-(VIX Index close – VIX Index 10-day moving average) is greater than or equal to 3.00 points

-(VIX Index close – VIX Index 10-day moving average) then declines for one day (i.e., the gap is less than the value yesterday and yesterday’s value was +3.00 points or more).

When this happens:

– Buy a put option on ticker VXX using the following guidelines:

-At least 40 days left until expiration

-The highest Gamma among near-the-money puts

Hold until:

The 4-day RSI for the VIX Index itself drops to 30 or below.

For the record, this strategy has an extremely limited track record, so I would not be too quick to jump on board.  Still the results are promising.

Figure 1 displays ticker VIX with some signal dates noted. Figure 1 – VIX Index (Courtesy: AIQ TradingExpert)

Figures 2, 3 and 4 display the most recent VXX trade signaled Figure 2 – VXX high Gamma puts (Courtesy: www.OptionsAnalysis.com)

Figure 3 – VXX Put trade (Courtesy: www.OptionsAnalysis.com) Figure 4 – VXX Put trade (Courtesy: www.OptionsAnalysis.com)

 Results

Figure 5 displays the hypothetical results (note no deductions for slippage and commissions) assuming that $2,500 was committed to each trade.  Also note that it is possible to have more than one trade on at a time. Figure 5 – Hypothetical Results 2012-2013

Summary

Again, this is a very limited track record.  Also, because this method looks at the raw number of points between the VIX close and it’s 10-day moving average (rather than a percentage difference) it is probably only useful when the VIX is at a relatively low level (i.e., below 20).

But it does provide one more potentially useful arrow in the quiver for an alert trader.

Jay Kaeppel

Today I want to highlight an option trading strategy that relatively few traders ever consider.  This strategy is known as the “Modified Butterfly”.  Since I am not entirely sure who coined that phrase I will give credit to John Broussard, the developer of www.OptionsAnalysis.com, the software I use for my own options, well, analysis.

(Please view my free “Finding Exceptional Opportunities” webinar at http://go.mta.org/watch112013)

The “classic” butterfly spread involves buying one in-the-money call (or put) option, selling two at-the-money call (or put) options and buying one more out-of-the-money call (or put) option.  An example of a “classic” butterfly spread appears in Figure 1, and the basic idea is to be able to make money of the underlying security remains within a particular price range.  Figure 1 – The “Classic” Butterfly Spread (Courtesy: www.OptionsAnalysis.com)

The problem with the “classic” butterfly is twofold:

1) If the underlying security makes a meaningful move in either direction you are out of luck.  For the record, I have found it just as difficult to predict when something “is not going to move” as it is to predict when something “is going to move.”  (In fact, early in my career, whenever I would put on a “neutral” strategy such as a butterfly spread or a calendar spread, it would invariably act as some sort of cattle prod to the underlying stock itself, and the quietest, sleepiest, most boring stock in the world would suddenly burst from the gate like a bat out of you know where).

2) Logistically you can run into the “inconvenience” of finding yourself long one in the money option, short two in the money options and long one out of the money option on expiration day.  If you hold this position through the close of option expiration day you end up on the following Monday with a position of short 100 shares of stock.  Surprise!  And not the pleasant kind for the unsuspecting.

The Modified Butterfly is essentially an attempt to put the odds slightly in your favor and to collect some option premium.

The Modified Butterfly (heretofore MB)

For the record, when the S&P 500 Index is above its 200-day moving average I prefer to look for MB’s using put options and when the S&P 500 Index is below its 200-day moving average I prefer to look for MB’s using call options.

Figure 2 displays an inputs screen from www.OptionsAnalysis.com for Modified Butterfly spreads on 11/4/13.  In a nutshell, we are:

-Buying 1 out-of-the-money put option

-Selling 3 puts at a lower strike price

-Buying 2 more puts at an even lower strike price

The ultimate goal of the trade we will find is for the stock to do anything expect decline sharply (i.e., rally, stay relatively unchanged, or drop only a little) and to keep the premium we collected when the trade was entered. Figure 2 – Modified Butterfly Inputs  (Courtesy: www.OptionsAnalysis.com)

Figure 3 displays the output.  This list is sorted by % Probability of profit.  Figure 3 – Modified Butterfly Output Screen  (Courtesy: www.OptionsAnalysis.com)

On the far right hand side you can see that a trade using SPY options has an 85% probability of profit.  However, two columns over to the left we see that the credit taken in on this trade is only 0.3%.  In a nutshell, we are risking $3,638 in order to make a profit of $12.  In my book, this is not enough profit potential to justify taking the risk.

Ideally, I want to see:

-Probability of Profit >= 75%

-Near P/L / Maximum Risk >= 5%

-Days to option expiration <=14

-No earnings announcement due prior to option expiration

In sum, I prefer to look for the opportunity to make at least 5% in 14 days or less with at least a 75% probability of profit and no impending earnings announcement that could upend the stock.

Further down in Figure 3 we find a trade using put options on AMZN that meets these criteria.  This trade risks $2,345 and takes in a credit of $155.  This represents a 6.6% potential return in just 11 calendar days. 

Figure 4 – AMZN Modified Butterfly  (Courtesy: www.OptionsAnalysis.com)

 Figure 5 – AMZN Modified Butterfly  (Courtesy: www.OptionsAnalysis.com)

As you can see, this trade will make money as long as AMZN stays above $351.73.

A few things to note:

-The basic goal is for the stock to not plummet in which case we simply keep the credit taken in when the trade was entered.

-However, because the downside risk is greater than the profit potential this IS NOT a “set it and forget it” type of strategy.  In other words, you need to think about in advance how you will react and what steps you will take if the stock starts to fall hard and the trade starts to accumulate a loss – especially if it reaches or exceeds the breakeven price.

-There is additional upside potential if the stock happens to be between the two lower strike prices at expiration.

-The biggest risk for a trade like this is “the huge gap down.”  Hence the reason I want to be sure there is no earnings announcement due prior to option expiration.  Likewise we are looking for a trade with no more than two weeks left until expiration so as to minimize the amount of time we are at risk.

As you can see in Figure 6, between 11/18 and 11/29 AMZN rallied sharply so all the legs of this trade expired worthless and the initial credit was kept as a profit.Figure 6 – AMZN stays above breakeven price of $351.73 (Courtesy: AIQ TradingExpert)

Summary

Traders and investors looking for an “income generating” strategy using options might do well to take a closer look at the Modified Butterfly spread.  If done right and managed properly this strategy can generate a series of relatively small profits that accumulate nicely over time.

The one “real world of trading” caveat to keep in mind is this: This is one of those strategies where one unmanaged losing trade can wipe out a lot of small profits garnered along the way.  So the two keys to success with this strategy are:

1) Follow the guidelines listed earlier to focus on the best opportunities

2) Develop a “fail safe” plan for each and every trade so that you are prepared when the “outlier” occurs (because eventually it will)

Jay Kaeppel

A long time ago I evolved into something of a “go with the flow” kind of guy – at least when it comes to the financial markets.  Sure, in my youth I spent a fair amount of time staring into my crystal ball and trying to “pick tops and bottoms with uncanny accuracy.”  Unfortunately, it took me a long time to figure out that my crystal ball was not actually functioning.

So I have long understood the benefit of simply using some objective method to define the trend is either “up” or “down”, and just kind of seeing where it leads.  This approach came in pretty handy in 2013 when the “news” was essentially uniformly bad from start to finish.  But did the stock market care – oh contraire!

Updating the old adage “Don’t Fight the Fed” into today’s jargon:

“If the Fed is pumpin’, the stock market’s jumpin’. ”

And at the moment, there appears to be no end in sight (at least regarding QE2IB, or “Quantitative Easing to Infinity and Beyond”). 

So why do I all of a sudden have a foolish hankering to buy gold stocks?  This makes no sense at all.  In Figure 1 you see four different gold stock related investment vehicles.  Can you say “well established downtrend?”  Sure, I knew you could.  Some have broken down to new lows others are still holding out hope of establishing a double bottom.  And for some inexplicable reason, I feel this urge to play the long side.  Figure 1 – Gold Stock Double Bottom; In the Making or Wishful Thinking? (Courtesy AIQ TradingExpert)

The key hesitation here is the simple fact that on the approximately last 57 times it “looked” like a potential bottom in gold stocks…….it wasn’t.  Will this time around be any different?  Probably not.  Still……….in the immortal words of Glenn Frey, “the lure of easy money, it’s got a very strong appeal.”

 To Give In Or To Fight the Urge?

Investing and trading is a game best played by establishing certain rules (for example, “go with the trend”, “cut your losses”, etc.) and then sticking to them.  But human nature is, well let’s be blunt here, a pain in the butt.  The urge to “pick a bottom” is one of the stronger, more compelling urges that any trader feels. What a coup if you pull it off (which of course you probably won’t)!

So here is the question?  If you feel the urge to “pick a bottom”, should you:

a) Fight the urge in every case?

b) Give into the urge and bet the ranch?

c) Give into the urge and risk a small, acceptable amount of capital?

If you picked answer, b) my frank advice is to let someone else handle your money.

If you picked answer a), more power to you and I greatly respect your discipline.

If you picked answer c) yo, what up dog!?  (Sorry, I inadvertently walked in on some video my kids were watching)

I personally can live with answer c).  For a couple of reasons.  First of let’s establish the fact that choosing answer c will probably lead to your losing money more often than not.  Sorry, that’s just the reality.  However, it can also serve as something of a “release valve”, whereby the occasional small mistake reminds us not to make a big huge mistake (i.e., answer b, somewhere down the line)

So let take a look at one possibility.

Finding a Trade (for better or worse)

I used www.OptionsAnalysis.com to look for long call trades on tickers GDX, GDXJ, XAU, NEM and GG.  Sorting for Bullish percent to double and then among the top trades chose the one with the highest Gamma (long story short, high gamma in my book equals more “bang for the buck”)

The trade I came up with was buying the GDX January14 22 call at $1.06 as shown in Figures 2 and 3.

So is this a good idea?  In all candor, probably not.  But let me just explain what I am looking at.

Let’s say I am a trader with a $25,000 trading account and are willing to risk (throw away?) 2% of our trading capital on a foolhardy attempt to pick a bottom (hey, it’s my account, I can do what I want).

This means I can risk $500 ($25K x .02).  So if the option trades at $1.06, this means I can buy up to 4 contracts and risk $424. Figure 2 – GDX Call Trade (Courtesy: www.Optionsanalysis.com)

Figure 3 – GDX Call Trade Risk Curves (Courtesy: www.Optionsanalysis.com)

So what are the likely (or at least possible) outcomes?

#1) Murphy’s Law being what it is, if I take this trade gold stocks will almost certainly continue to sink.  In this case the worst case scenario is that I hold the calls until January expiration and lose $424.

#2) if somehow, the market gods smile, let’s assume that GDX bounces back up to its early November high near $24.70.  In this case, the trade will generate a profit of $660 to $880 or more, depending on how soon GDX bounces.

Summary

As a rule I would never advocate for someone else to “pick a bottom”.  But let’s face, every once in awhile, the urge strikes.   So if you decide to give into the urge, make sure:

a) You don’t risk very much money.

b) You have enough upside potential to at least make it worth your while to do something that you may well look back upon and say, “Why the heck did I do that?”

As long as you employ a) and b) above, I view it as sort of a win-win situation (depending of course on how you define “win”).

If the underlying security in question does bounce to higher ground, you have the opportunity to generate a nice profit.

On the other hand, if the underlying security continues its current trend, you are served a powerful reminder of why you don’t try very often to “pick tops and bottoms with uncanny accuracy.”

So the bottom line is this: I am NOT telling you that I think gold stocks are about to bounce and that you should buy gold stocks (or options on gold stocks).  What I am telling you is that sometimes the urge to speculate will rise to the surface.

When that urge strikes there is a right way and a wrong way to react.

Happy Thanksgiving

Jay Kaeppel

Under the category of “This is Not a Recommendation, Only an Informational Tidbit” (Note to Myself: Come up with some better categories), keep an eye on real estate stocks in the weeks ahead.

A Seasonal Trend of Note in Real Estate Stocks

A bullish time period for real estate stocks begins at the close of trade on the 14^th trading day of November (this was 11/20/13 this time around) and extends through the 21^st trading day of December (12/31/13).

Figure 1 displays the growth of $1,000 invested in ticker FRESX (Fidelity Select Real Estate) during this time period every year since 1989.

 Figure 1 – Growth of $1000 invested in Fidelity Select Real Estate (FRESX) 1989-Present during Bullish Seasonal Period

FRESX has advanced 20 times during the past 20 years during this time frame, or 83% of the time.

Other potential investment choices beyond FRESX include:

Ticker VNQ – Vanguard REIT Index

Ticker IYR – iShares Dow Jones Real Estate ETF

Ticker URE – ProShares Ultra Real Estate ETF (2 x leverage)

Ticker REPIX – Profunds Real Estate mutual fund

Will real estate stocks rally this time around?  Only time will tell.

Jay Kaeppel

Please find below a complimentary link from MTA (Market Technicians Association) to an archived version of my 11/20/2013 webinar titled “Finding Exceptional Opportunities with ETF, Options and Seasonal Trends.

http://go.mta.org/watch112013

Please find below a complimentary link from MTA (Market Technicians Association) to an archived version of my 11/20/2013 webinar titled “Finding Exceptional Opportunities with ETF, Options and Seasonal Trends.

http://go.mta.org/watch112013

My thanks again to MTA for inviting me to speak and for all those in attendance.

Jay Kaeppel

Hi Jay, welcome back to your own blog.  Yes it has been a little while since I have posted anything new.  Sorry about that.  I was a little busy preparing for a webinar I taught on 11/20 for MTA.  Also, there wasn’t anything really compelling happening in the markets that jumped out at me.

For the record I should probably point out that in a good week I will probably post two new items.  First off, I tend not to write “short” pieces (although, shorter ad more frequent pots is something I am aiming for in the future), plus I don’t foresee ever posting “daily commentary”.

If you took the sum total of all “Daily financial market commentary”, in a nutshell it basically amounts to “blah blah blah.”  No disrespect to anyone writing daily commentary, its jut that there I not always anything meaningful driving the markets on any particular day.  But if your job is to write about the markets today, well, you have to say “something.”  So there tends to be a lot of after the fact causation assigned to random events.  For example:

“The Dow rose 66 points today as investors looked at their checking accounts and found that they actually had a few more dollars there than they thought and were cheered, which somehow resulted in high frequency trading programs kicking into “buy mode” for a good portion of the afternoon, which was really the only time of day that the market did anything all day.  In “economic news”, financial “experts” adjusted their estimates for 4^th quarter GDP growth from +1.2% to +1.2000000001%, which I am also going to claim somehow compelled people to buy stocks aggressively enough to make the market go up, even though as I have already said, today’s action was solely based on high frequency trading programs.”

Insightful or what!?

Anyway, in my MTA presentation one of the things I talked about was the tendency for financial stocks to perform much better during the last 4 and first 2 trading days of the month than during the rest of the month (and when I say “much better”, I mean “MUCH better” – like +1,863% versus -87% over the last 25 years).  Also, one of the points I made in regards to trading in general is the importance of “consistency of returns”.  The more consistent the returns from any trading method the easier it becomes to continue to follow the method without second guessing things based on “current events.”

So one of the questions that an attendee raised was the month-to-month consistency of my seasonal systems for financial stocks.  So here are the figures:

Figures for Jay’s Seasonal Financial Index Trading System

Please attend the free on-line seminar that I will be teaching on Wednesday, November 20th.

Info link: http://tinyurl.com/nys8rqj

To attend live webinar for no cost visit: http://go.mta.org/lobby112013 on 11/20 before Noon EST

One of the long time debates among market analysts is arguing the relative merits of “growth” stocks versus “value” stocks.  Some argue that earnings growth is the name of the game when it comes to great stocks.  Others argue that it is best to buy them when they are “giving ‘em away.”  So who’s right and who’s wrong?  It beats the heck out of me.  In fact, my own analysis suggests that there is a “time for value” and a “time for growth.”  Nevertheless, this article will detail a system I’ve developed that only trades vgrowth stocks – “when the time is right.”

The Benchmarks

Figure 1 displays the growth of $1,000 invested in Vanguard Growth Fund (VIGRX) and $1,000 invested in Vanguard Value Fund (VIVAX) since January 1994.  Some will look at Figure 1 and state that growth stocks are “better” than value stocks because they have generated a greater profit.  But as you can see, through the 2008 decline they were basically even.  Since that time growth has vastly outperformed value.  But history suggests their performance will converge once again somewhere down the road.

 Figure 1 – $1,000 invested in Growth stocks (blue line; ticker VIGRX) versus $1,000 invested in Vale stocks (red line; ticker VIVAX) since January 1994

As it turns out it is possible to build a model that invests only in value stocks, yet outperforms both of these indexes by moving to cash on occasion (roughly 15% of the time).  So here goes:

Jay’s “Show Me the Growth” Model (SMTG)

To those who dislike math all I can say is “just grit your teeth and you can get through this”.  Here are the calculations:

A = Daily close for VIGRX divided by daily close for VIVAX

B = 39-day exponential moving average of A

C = ((A – B) / B) * 100

D = C – 1.2

(That wasn’t so painful, right?)

“Show Me the Value” Trading Rules

-If yesterday’s value for D < 0 then buy Growth stocks at the close today (or continue to hold value stocks if already long).

-If yesterday’s value for D > 0 then sell Value stocks at the close today (or remain in cash if already in cash).

That’s all there is to it.

Now, let’s try it in English and then look at the results.

Figure 2 displays the daily values for variables A and B above.  The blue line is Value A and is derived by dividing growth stock fund (VIGRX) price divided by value stock fund (VIVAX) price.

The red line is Value B or the 39-day exponential moving average of Value A and is arrived at by multiplying yesterday’s value for B times 0.95 and today’s value for A by 0.05 and adding the two together.  When the blue line is above the red it indicates that growth stocks are outperforming value stocks. Figure 2 – VIGRX divided by VIVAX (blue line) and 39-day exponential moving average (red line); August 2012-Present

Figure 3 displays value C which is the difference between the two lines shown in Figure A as a percentage (again, A-B and then that value is divided by B and then multiplied by 100.  Are we having fun yet?) minus 1.2.Figure 3 – “Show Me The Value” Signal Line (Below 0=Long Value Stocks; Above 0=Cash) ; August 2012-Present

As long as the Value D shown in Figure 3 is negative we want to hold growth stocks.  When that value moves to positive territory we move to cash until Value D drops back below 0.

System Results

OK, so what the heck do all these gyrations do for us?  Well, they give a us a pretty decent model for making money in the stock market and does so with lower degree of volatility than experienced using a buy and hold approach.

To make a comparison we will compare the growth of $1,000 invested using the system versus the growth of $1,000 split equaling between VIGRX and VIVAX on a buy and hold basis.  While the system is in cash we will assume a nominal rate of interest of 1% per year. 

Figure 4 – Growth of $1,000 using SMTV System(blue line) versus Buy and Hold (red line) (1994-present)

Figure 5 – Performance Comparison

Figure 6 after the article shows the annual results

In a nutshell, the system has:

-Outperformed a buy-and-hold approach (+14.2% annually and +1,101% in all versus +9.4% annually and +331% in all)

-And has done so with less volatility (annual standard deviation of 15.1% for the system versus 18.4% for buy-and-hold)

-And less risk (maximum drawdown of 33.8% versus -55.9% and a worst calendar year of -10.5% versus -30.9%).

Summary

So should everyone abandon their current investment model and adopt this one?  Should investors completely abandon growth stocks and invest only in values stocks as this system does?  And will this system outperform buy and hold ad infinitum into the future.

The answer to each of these questions is “probably not.”  Still, in the end we are talking about an objective, mechanical system that averages 14% a year, outperforms buy and hold and does so with less volatility.

As a proud graduate of “The School of Whatever Works”, all I can say is “I’ve seen worse.”

Jay Kaeppel

OK I am beginning to become something of a broken record.  I keep talking about following the trend (in case you have not noticed, the trend is “Up”), but then I keep fretting and talk about hedging against a near-term decline using call options on ticker VXX (the exchange-traded fund that tracks the VIX Index).

So which is it Jay, up or down?  Well, I claim it can be both.  You can be a bullish long-term trend follower and still be concerned and take action to hedge against a short-term decline which does not include “selling everything”.

The Good News

The good news is that the stock market is clearly in an uptrend and in addition (and as I wrote about here (http://jayonthemarkets.com/2013/11/04/santa-claus-is-coming-to-town/) the Santa Claus Rally Time Period begins at the close on 11/22.  So in a perfect world one would simply leave well enough alone and enjoy the ride (in case you have not noticed it is not exactly a perfect world).

The Bad News

The bad news is that several indicators that I follow are starting to give warning signs (albeit minor ones) and ticker VXX itself (http://jayonthemarkets.com/2013/10/30/is-vxx-issuing-a-warning/) is currently the picture of complacency.  So I have concerns about the stock market in the very near term.  At the same time I do not want to “sell everything” and load up on short positions.  So what to do?  Man the VIX!

VXX Call Option

The position I am looking at involves buying the December VXX 13 strike price call option.  As this is written ticker VXX is trading at $12.29 a share and the December VXX call is trading at $0.59 (or $59 for a 1-lot).

In Figure 1 we see the utter lackadaisical action of late in ticker VXX.  My own subjective interpretation is that after the shutdown/debt limit “crisis” ended the investment world went “OK, back to the bull market, blah, blah, blah.”    Figure 1 – VXX is the picture of “complacency” (Chart courtesy of AIQ TradingExpert)

The thing to note here is that the Average True Range (shown below the bar chart) is down to a level that preceded the previous to “spikes” in VXX.

The December 13 VXX trade is displayed in Figures 2 and 3. Figure 2 – VXX December 13 call option details (Courtesy: www.OptionsAnalysis.com)

Figure 3 – VXX December 13 call option risk curves (Courtesy: www.OptionsAnalysis.com)

So in light of all of this, you have got to ask yourself two questions:

Question #1: Do you have any concerns about the stock market in the short-term, “yes” or “no”.

If you answered “yes” to Question #1, please proceed to Question #2.

Question #2:  Do you have 59 bucks?

Jay Kaeppel