9/6

Didn't have a chance to post yesterday, but I did execute a trade.  I set up a strangle on the DIAmonds with a Sep 136 call and a Sep 128 put.  I paid $1.00 for each position.  TK gives a 'strangle price' when you enter that strategy which saves you typing in the order twice, but I noticed that I paid a nickel more than I should have on one side of the trade.  My advice is to do the trades sequentially and set up the strangle manually, because using the 'strangle price' did not provide me with the best execution.

Anyway, I sold my WAT Nov $65's to fund this trade.  I gave up on Waters with the position down ~25% out of sheer boredom.  It's a good long-term buy, but in the short-term the defensives seem to be wallowing, and I wanted a little more action from that capital.  I am not done with WAT yet, so stay tuned for more on that one in the coming weeks.

So the strangle puts me in a position of benefitting from a sharp move in the DJIA in either direction.  This is the way to play volatility.  I often see VIX contracts referred to as 'volatility plays', but VIX is a way to play implied volatility, not actual volatility in price movements.  Implied volatility measures the amount of risk that is being priced into an option that is specific to that options. IV is a calculation of risk, not amplitude and VIX is really a measure of risk aversion --or call it fear, if you like. Put another way, being long VIX only pays when the market is going down (and risk aversion is increasing), and the market is increasing the odds that more big declines could come into play, making near-term call options more risky.  So, on a day where the market drops 300 points then rises 350 points, you would likely lose money being long VIX.

But a strangle really does allow an investor to play volatility. And that's what I am looking for, starting with tom'w's employment report.  I am not talking about some small intra-day gyrations, but big time, multi-hundred point moves on the DJIA...the kind that get reported by NBC, as well as CNBC.

Basically, every market action will be a minor movement leading up to the crescendo of the FOMC mtg. on Sep 18th.  This is the Big Daddy...a guaranteed market mover, and with this bet, I don't have to worry about direction.  Sep options expire 3 days later, so I think the market will have been sufficiently riled by the Fed for meaningful moves b/w now and then.  SO b/w now and then all eyes will be on the data that the FOMC will analyze and no number is bigger in the Street's eyes than the monthly employment report. 

August's jobs # comes out tom'w @ 8:30 AM. Consensus for the jobs # is 123,000 and the recent revisions have been largely negative.  So, a very strong number (say 180k plus) would scare the market into believing the FOMC cut which has been priced into both stock and bind markets may not happen this would not be good for equity prices (yea, DIA puts!).  Similarly, given current sentiment, a very weak number (below 75k) would probably lead stocks lower, as fears of the effective a slowdown would offset the fact that weaker jobs data would make Fed action a slam dunk (or close to it).  So the sweet spot is probably b/w 100-150k jobs and that could provoke a huge rally --not too hot (Fed will still cut rates )/not too cold (companies will still be able to grow earnings).

Then it will be a steady week and a half of jabbering over the jobs data and every other economic data point, in an attempt to divine the Fed's move.

But it's not over with the FOMC, as MS, GS, LEH and BSC  all report that week--after the Fed's meeting, but before Sep options expiration.  How much did the credit crunch and subprime mess affect August quarter earnings from these banks and how much will future quarter profits be affected?  Some (downward) estimate revisions have trickled in, but I really think the brokerage earnings will be much more eventful (i.e. market-moving) than usual, given the unprecedented conditions in August.

So, I am looking for moves, big ones, and lot's of 'em.   As usual, I use the DIAmonds (the ETF derived from the DJIA) rather than the SPYders, which are derived from the S&P 500 . 

The DJIA is a price-weighted index in which all 30 stock prices are multiplied by a common factor (you can find this # in Barron's every week) to produce the index value. 

The DJIA itself is basically useless, then, because the index is very heavily weighted toward stocks that have a high price per share.  For instance, a 1% move in IBM (a $117 stock) is worth 4x as much in 'index points' as a 1% move in MIcrosoft. This is completely nonsensical. If you had a truly equal-weighted portfolio, the moves would have equal impact, and if you had a market-cap weighted portfolio (as the S&P 500 is constructed) , the MSFT move would be worth much more as MSFT's market cap is 60% higher than IBM's.

There's just no reason that the level of the individual stock price should matter at all--other things equal it's just a number, and offers zero resistance to buying the stock with rare exceptions like BRK.A.  In the real world, owning 10 shares of a $10 stock is no different than owning 1 share of a $100 stock.  If  Santa brought you one share of each of the 30 companies for XMas, the DJIA would be a great index, but in the real world, no one constructs a portfolio that way (I hope)

Also, the arguments over the relevance of the 30 companies vis-a-vis the overall economy are specious because the calculation of the index itself s so bogus, I don't think it really matters.   It's outdated, misleading, and presents inefficiencies...and that's why I use it!

I believe the dubious calculation methods lead to exaggerated moves in the DJIA in any given day, year or decade, and as an options investor, I see greater real volatility as real plus to investment.  What I am really hoping for are large percentage moves, 5%-10%, etc. and based on the way it calculated there is a much better chance of those moves in the DJIA than in the S&P 500.