What’s a “Good Deal” in Trading?

07/14/2008 12:00 am EST

Focus:

Tom Busby

Founder and CEO, DTI

Someone once said that "a good deal is defined by something that costs 50% less than the previous week." I suppose Americans like deals.  If you're searching for a "deal" on laptops and Dell has the one you want at a 20% discount, well that's a "deal".  But the current market environment is not that simple; in other words, don't be a buyer simply because prices are lower right now.  The average American has not the proper education, nor deep enough pockets to sustain, nor ride out the downside of these conglomerates.  One of my favorite quotes is, "the market can stay 'irrational' longer than you can stay solvent."  Think of this logically, if the hottest electronic device is selling for $100 this week and next week it is on sale for $50, would you want to buy it?  Would you at least ask the question, what is wrong with it? 

Certainly all of us have the ability to become suspicious of a truly good deal.  This market has been beaten to the ground, brought back to its knees by the Fed, and then beaten again.  You have to know when to realize that enough is enough, especially if you are approaching or are in retirement age.  Having the knowledge to take advantage of downturns in the market and parlay them into a hedge or even better, extra cash is vital to your ability to sustain your wellbeing given these volatile times. 

Last week, during the FOMC announcement (which occurs only eight times per year) there was a small rally off of the expected announcement that Ben Bernanke would hold interest rates steady.  Once that rally began to dissipate, the bottom fell out.  As I watched the market fall from the Fed decision, I took several day trades in the futures indexes, including the e-mini Dow and e-mini S&P 500.  Chart 1 is a daily chart of the e-mini S&P July 1350 Calls since the FOMC announcement. 

 


Chart 1 - Daily E-mini S&P July 1350 Calls

 

Chart 2 is the September e-mini S&P futures contract during the same time period.  A premium of 15.00 was brought in on the options and they have not looked back since, as they are now trading at 0.45. 


Chart 2 - Daily September E-mini S&P Futures

 

If this sounds risky, take a look at the average investor whose portfolio is at six-year lows.  The average investor who is not paying attention to this and thinking about his retirement or well-deserved vacation is risky.  Keep in mind a stock falls faster than it takes to go up.  There are quite a few ways to skin a cat, and my selling premium was only one of them.  A less risky strategy of buying puts on equities in a portfolio would have worked out nicely, or even buying puts on the overall market would have earned profits.  If you are managing what is supposed to be a low volatility traditional IRA you could buy inverse pro-shares.  The list of ways to profit in a falling market goes on and on.  So if you still think that buying a low priced stock is a good deal, keep in mind you can only lose 100% of your money.  The bottom line is, learn a method for investing and stop losing your hard earned money.

By Tom Busby
www.DTITrader.com

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