Ares Trading

The following positions were closed and will be discussed in order: DIA, F, QQQQ, XLF

DIA: The Dow Jones Industrial Average dropped on Monday, creating 50% profit for the put position.  However, the order wasn’t made before the close of the market.  On Tuesday morning the contract was sold for 46% profit before the rally started.  This was an example of great timing.

F: Monday’s drop in the Dow Jones Average affected Ford’s shares as well.  These put contracts were trading at around 40% premium, however the order did not make it before the close of the Monday market session.  Similar to the DIA position, these contracts were sold for 32% profit Tuesday morning, before the rally.  Another example of great timing.

QQQQ: The Nasdaq index rallied on Tuesday as well, ending up 2.45%.  This position was opened at a time when these call contracts were overpriced due to volatility.  Thus, even with a dramatic increase in price the contracts only sold for 9% profit.

XLF: This position was sold at the wrong time, an example of BAD timing.  The call contracts were down around 40% the day before.  Ares Trading played conservatively and cut losses short at 17%  in the morning, as XLF began its rally.  Ares Trading did not have faith in the upward momentum.  As the financial sector rallied with the overall market, the contract increased in value.  If these contracts were sold at the end of Tuesday instead of the beginning, they would have sold for $1.86, resulting in 5% profit.

There is an inverse correlation between the Dow Jones Industrial Average (measured by the DIA Diamonds ETF) and the DBC (Commodities Tracker ETF). This is a logical relationship since when oil costs are high, the market, in particular, industrials do poor. Thus, when oil prices rise, gold, and other commodities will rise, all part of the DBC ETF. In response to higher oil and commodity prices, the Dow Jones index will suffer, as the market will turn bearish on stocks.

Ares Trading believes the recent upswing in the Dow Jones average will be corrected as oil returns to above $135 a barrel. Consequently, Ares Trading has bought naked calls on the DBC Commodity Index ETF and naked puts on the Dow Jones Industrial Average (DIA ETF).

Ford Motor is having a tough year. Rising fuel costs have ended the “Big-Vehicle Era”, and Ford is having a hard time adjusting. Ares Trading believes the recent rally is a perfect opportunity to be bearish on Ford. Thus, naked put contracts, at $5 strike, have been purchased for August expiration. Ares Trading believes Ford will retest $4.5 lows set early in July.

Technology is a safe bet right now. In the recent rally, Financials have been the only sector to experience a large upswing. However, during the sell-off all sectors were hit very hard, especially technology. This has created unusual valuations for many strong technical companies, many of them being underbought. Ares Trading believe there is strong upside risk for Tech, and thus bought naked calls on QQQQ (Nasdaq Index ETF).

The final position Ares Trading initiated today was in XLF. This is a contrarian position and is being used as a hedge against the QQQQ and DBC position. Ares Trading believes that if Financials are to perform well, then Commodities (DBC) and Technology (QQQQ) will suffer. Why? This is because any positive news will provide enough for a large upside swing for Financials. This will cause market makers to sell off Commodities and Tech, in order to switch assets into Financials. In addition, Ares Trading believes that Financials have been highly oversold. Although fundamentals problems exist, they will continue to exist until 2010, and there is no way to predict a bottom for Financials.

If there is any movement in Financials, it will be dramatic and thus Ares Trading believes the upside risk outweighs the downside risk. Using naked calls on XLF (Financial Sector ETF), Ares Trading is betting on a dramatic momentum shift before the third week of August, similar to the recent market rally.

This article was found from Seeking Alpha.

Thomas Tan, a 15-year market veteran decided to follow a hedge fund manager’s “10 predictions for the year” and wrote this article for Seeking Alpha.  He speculates about 10 things to happen in 2008 and he is quite accurate.  Here are some of the highlights:

“The price of gold will reach quadruple-digits in U.S. dollars ($1000) for the 1st time in human history. Gold has entered the 2nd phase of its uptrend, and will have more explosive up movements, and become more volatile. We should see $50+/- intraday movement in 2008. But this gold bull market has a long way to go beyond 2008.“

“Energy prices will continue to rise. We should finally see oil hit triple-digits ($100 and more), and a decent recovery of the natural gas market with inventory level declining. Against popular opinion, higher oil prices will neither reduce global demand, nor increase global supply.”

“Citigroup (C) will drop into the teens (below $20), and there is more bad news to come in the banking industry. Less than half of the subprime write-downs were announced in 2007, with the other half still to come. The OTC derivative market is full of land miners, and like steroids in professional baseball, we still don’t know all of the ramifications, or situation of each player (bank). We know many of them are having problems and will hear more explosive news in 2008.“

“After a temporary rebound, the U.S.dollar will continue its downtrend, as an inverse mirror image of gold. The U.S. dollar will lose another 10% of its value, and the U.S. dollar index will hit 70 sometime during 2008.”

The American and global financial markets are currently very volatile. The financial firms are still in the process of writing down their illiquid securities and the market sentiment is strongly bearish due to high oil prices, inflation, and a much lower dollar.  Any negative news, such as rising oil costs, or a sector leader missing their earnings can cause a quick intra-day sell-off. Ares Trading cannot speculate in the current market state, rather there are larger macro issues which can be used for proper investment.

Financials have been hit hard, which can be seen by the Sector ETF: XLF performance in the last month. However, many firms have been hit harder than others due to the overall bearish sentiment for the financial sector. These firms face an upside risk. Research is being conducted on which Financial firms are currently drastically undervalued and have the potential to return to normal multiples.

An example of this was the quick trade made on LEH (Lehman Bros). Naked calls were purchased the day the share price hit $12.80 (18% decline in one day). Rumors were out that Dick Fuld, CEO, would take the firm private if the firm wasn’t valued higher. Sure enough, Lehman hit its support and had an upside momentum since. A quick 26% return within 6 days.

Other bets didn’t fare as well, i.e. SSL and PRGS calls. PRGS (Progress Software) was an earnings play which didn’t work out because although the company did beat consensus, they lowered their guidance. This sent the stock price into a strong downward movement. The calls should have had been sold by STOP-LOSS before they lost over 90% of their value. SSL (Sasol Ltd.), the South African integrated Oil and Gas company was simply a wrong pick in the short term. Although the company has strong fundamentals, it has been a victim in the recent sell-off. In the future there has to be more discipline and losses have to be cut at 30%.