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My Attack Plan for 2012…

As if you were not already painfully aware, the 2011 stock market, was horrifically difficult to trade. Last year may go down in history as the second most volatile year in terms of frequency of

As if you were not already painfully aware, the 2011 stock market, was horrifically difficult to trade. Last year may go down in history as the second most volatile year in terms of frequency of market reversals, magnitude of reversals, and a year where the market was almost completely driven by politics (mostly very bad politics), European economic triage and the most frightening of all, the all-too-obvious ‘Emperor-has-no-clothes’ syndrome of massive and unsustainable debt (globally and domestically) that all but the most naive (who are running our country) know a day of reckoning is coming at us like a freight train. Perhaps that sentence had too many metaphorical references, but I am sure you get my point.

16 times in just the last 9 months of 2011, the market significantly reversed course in a matter of a few days to very few weeks. 11 of those 16 times, the market dramatically reversed course by 5% or more. Take a look at the following chart of the DJIA for 2011:

Here are the details:

  • The average duration of each market swing was 12 days.
  • The average move in the market was 7.6%. Keep in mind that 10% is considered a full correction.
  • For the 13 days ending on 3/16/2011, the market dropped -5.01% (Circle A).
  • For the 16 days ending on 4/6/2011, the market jumped higher by +7% (Circle B).
  • For the 9 days ending on 4/29/2011, the market bounced higher by +5% (Circle C).
  • For the 33 days ending on 6/15/2011, the market fell by -7.13% (Circle D).
  • For the 9 days ending on 7/7/2011, the market shot back up by +6.58% (Circle E).
  •  For the 14 days ending on 8/9/2011, the market tumbled by -11.67% (Circle F).
  • For the 4 days ending on 8/15/2011, the market reversed course by +7.12% (Circle G).
  • For the 4 days ending on 8/19/2011, the market reversed again and dropped -5.79% (Circle H).
  • For the 20 days ending on 10/28/2011, the market surged higher by +14.79% (Circle I).
  • For the 10 days ending on 11/25/2011, the market fell back lower by -7.59% (Circle J).
  • And for the last significant move, for the 9 days ending on 12/7/2011, the market recovered +5.84% (Circle K).

2011 did not see the European debt crisis resolved. 2011 did not see the US debt problem even addressed. 2011 did not see a world leader surface with a real plan for moving back from the economic abyss. Quite the contrary, the ‘leader of the free world’ and his political reelection machine have taken a ‘who-cares-what-happens-so-long-as-he-gets-reelected’ attitude. I worry this attitude of applying political expediency over doing the right-thing regardless of the political consequences, ‘could’ push us past the point of no return… if we are not there already.

It would not surprise me to see 2012 be just as bad, if not worse than 2011 in terms of market volatility. This Presidential election year has the increasing likelihood of vote-buying in one form or another which will push the market higher, the lack of any solution in sight for Europe which could push the market lower, and the festering cauldron of war in the Middle-East which, if ‘more’ war does break out, markets and market segments could fluctuate in a big way. Of course, we should not lose site of the fact that China is rubbing their hands with glee as the ‘West’ crumbles under the weight of massively out-of-control so-called entitlements. All of this could give us another year where fear and emotion do more to drive wild swings in the market than economic realities of currency stability, economic growth (or lack thereof) and earnings. We ‘could’ see another year where every few days or weeks, we rotate from the-world-is-coming-to-an-end to happy-days-are-here-again… only to reverse that thinking a few days or weeks later. Yes… 2012 ‘could’ be far worse than 2011. Hopefully, it will not be as bad as 2011, but having the right plan and trading strategy could prove very rewarding in an otherwise hard-to-navigate stock market.

Here is My Plan…

My plan is quite simple, actually… If the market is going to throw a lot of volatility at us, then let’s sell volatility… kind of along the lines of ‘if all you have are lemons… make lemonade!’

I began implementing this strategy in late 2011 and am impressed with the results. I plan to expand upon this plan in 2012. Here are the details:

1. My first assumption in this plan is that we cannot depend on long-term trends of weeks, much less months of trends holding together. Therefore, I will use my long-term strategy that is implemented one week at a time.

2. I will limit my universe of players [equities] to primarily those that have sufficient options liquidity and most importantly, weekly options.

3. My second assumption is the market will move appreciably higher at some point in 2012 and will move appreciably lower at some point in 2012. As such, I may well have both bullish and bearish trades on at the same time, just as I do right now.

4. My primary strategy will be to sell volatility each week via covered call options. Here is how this works… I will buy equities that have good weekly option liquidity. Weekly options are options that open on Thursday of each week and close the following Friday. I like the weekly’s because of the rapid time decay of the options and the fact that my strategy is only exposed to the market one week at a time.

5. Selling weekly call options produces immediate income that, in effect, buys down my basis in the underlying equity. Each week, I will sell calls that are enough out of the money to provide a very solid profit if the underlying equity is called away (meaning the price of the underlying moves up above the strike price of the call and my shares are sold at the strike price). I want the strike to be slightly higher than I believe the underlying price will move to, which means the contracts would expire worthless each week, and I would then sell the upcoming week’s calls. I plan to do this over and over and over on the same underlying until it is taken from me in a big move in the market, which will generate a very solid return. Bear in mind that each time I sell a call against my position, the net effect is the basis of the equity is lowered by the amount of money received from the sale of the call.

6. I plan to stay at or near 100% invested for most of the year, but will use my forecast charts to give me a tactical bias (see 12-month S&P 500 forecast, below). When the market is in bear-mode, my strategy will be to hold more inverse ETFs and continue to sell weekly calls. When the market is in bull-mode, my strategy will be to hold more long biased equities and sell weekly calls.

7. The above strategy works both for bear plays and bull plays as long as I am patient enough and my basic assumption is correct, which is the market will likely move quite a bit higher at some point in 2012 and the market will likely move quite a bit lower at some point in 2012. If this assumption is wrong and the market stays flat, I will make money from the sales of call contracts every week. If my assumption that the market will, at some point in 2012 move lower, and the market only moves higher, I will make money on my long biased trades as I sell weekly contracts AND when my underlying is called away from me. If the market only moves appreciably higher and never moves lower in 2012, my short biased trades will lose money, but since I am selling weekly calls, the basis will continue to move lower and my net loss will be mitigated. The opposite is true if the market only moves lower in 2012. I will make money on my short biased trades and will lose money on my long biased trades, but that loss will be mitigated [lowered] by the income derived from the sale of the weekly call contracts.

I am very optimistic about this trading strategy. The key, of course, will be picking the right equities and the right calls to get the maximum return. Playing both a bearish strategy and a bullish strategy while collecting income at a rate that far exceeds near zero interest rates is also a good strategy. Having a longer term holding on quality dividend-paying stocks will also come into play for additional income.

I’ve long said we are under-utilizing nuclear energy. This shouldn’t be controversial; nuclear has something for everyone.