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December Gold is closing on a downside target we’ve been using for a short position entered by subscribers more than $100 above the current price. I’ve suggested in today’s Comex Gold analysis a hedging strategy with GLD calls that can be used if and when the target is closely approached. Independent of this recommendation is another that would attempt to leverage a more immediate bearish target in GLD itself. This can be done either by buying the ETF at or very near the targeted level, or buying call options when it gets there. For details, check out the GLD  forecast and analysis elsewhere on this page.

The news media went all-in over the weekend trying to explain the significance of the Gamestop saga, but because few traders were asked about it, there was little in this torrent of analysis to enlighten. Most of the reporters, talking heads and pundits focused on the obvious, sensationalizing a story about how the little guys have drawn first blood and are about to stick it to giant hedge funds by targeting their short positions. This kind of claptrap makes for salacious reading, but there’s a much bigger story that has so far gone untouched. Before I explain, here’s some point-and-counterpoint to get you past the disingenuous swill being dished out in the blogosphere and by the mainstream media:

Popular Narrative:  The Reddit/Robinhood mob (RRM) has declared war on hedge fund biggies, and so far the smart money has been getting its butt kicked. Reality: The damage so far is just a mosquito bite on the behind of hedge fund elephants like Steven A. Cohen, and the Reddit mob a five-year-old who has discovered where Daddy keep the matches.

PopularNarrative: “We’re going after Citadel next!” Reality:  Nice try, kids, but this kind of hubris is going to boomerang  on you. As a rallying cry, it makes good headline fodder, since the name ‘Citadel’ conjures up the financial establishment’s most impregnable fortress. In the end, though, you can bet on Citadel & Friends to change the game so that the edge you pishers currently enjoy evaporates quickly, assuming it hasn’t already.

Popular Narrative: “After Citadel, we’re going to squeeze shorts in silver.” Reality: We’re actually rooting for you on this one, since precious-metals markets are manipulated by unmitigated scumbags. And, yes, your merely having announced last week that silver is in your cross hairs seems to have provided a little added boost to silver quotes on Thursday and Friday. But before you take on the commodity markets, better read up on Nelson ‘Bunky’ Hunt, a billionaire when that was real money, but also a trader smarter than all of you put together. He got crushed trying to corner silver even though he’d done everything right. Hunt would have succeeded if Comex had not raised margin requirements to such heights that only two players were left in the game: Hunt and Eastman Kodak.  This killed speculative demand, and eventually Hunt himself.

Popular Narrative: The Reddit/Robbinhood mob (RRM) has been making money hand-over-fist. Reality:  The number of big winners is probably far smaller than imagined by the blogosphere and news media, and the sums are smaller. Don’t assume that all of the greedy little guys got out at the top, or that they will. Some will predictably become such believers in their omnipotence that they may actually buy the top, as occurred at the end of Bitcoin’s first mania.

Popular Narrative: The little guys have outfoxed the smart money. Reality:   For a nanosecond, maybe. But how smart are they, really? Probably not one of them in 500 understands that certain option strategies they love to use, such as covered-writing exploding stocks, can backfire lethally. In fact, out-of-the-money options they’ve sold can be exercised, and this can happen well before the options expire. The unavoidable result is a stock-settlement mismatch that can turn seemingly winning bets into unanticipated disasters overnight. We may be hearing more about this soon.

Popular Narrative: Regulators will soon put a stop to this nonsense. Reality: No, they won’t. For one, the kids haven’t actually broken any laws; targeting shorts is nothing new, and it is only the ease of doing it in the blogosphere that is causing regulators to gnash their teeth and tug at their hair. For  two, the ability of institutions and other players to short stocks with little hindrance is essential to keeping the markets running smoothly.

The Power of Desperate Buying

Now to my salient point, and it is this: A mere week’s worth of short-targeting shenanigans has permanently altered the game in ways that will have deep and lasting consequences. To be clear, let me say again that SAC, Citadel and the Comex do not fear the mob on social media; rather, they understand that the would-be giant-slayers eventually will self-destruct because of their ignorance, inflated self-importance and reckless boldness. However, the Smart Guys do recognize that the war is asymmetrical, since the little guys don’t need to put any skin in the game to trigger off a massively costly short squeeze.  All the little guys need do is mention in a chat room that a particular stock has short interest greater than, say, 25% of the float, and the squeeze is on. This kind of war is so very asymmetrical that Big Money cannot possibly fight it.

What this implies is that over time, short interest will eventually diminish to the point of insignificance. The bottom line for the stock market is that bull markets will become less bullish, and bear markets more bearish. Why? Consider that short covering is the most powerful propellant of bull markets. That’s because it is the only source of demand sufficiently urgent to push stocks through otherwise impenetrable layers of supply and daunting prior peaks.  I say ‘urgent’, but ‘desperate’ is probably more accurate, since short covering is driven by margin calls from brokers frantically worried about a customer’s solvency.  When we talk about buying the dips, the main buyers on market weakness, even moreso than bargain hunters, are short-covering bears.

How Bear Markets Work

Short-covering is also the force behind the breathtaking rallies that occur in bear markets. From a psychological standpoint, the “purpose” of these rallies is to convince investors that stocks have turned the corner and are in a sustainable rebound. Short-squeeze spikes are a routine feature of bear markets, and they recur until an exhaustion spike going in the other direction destroys the last vestige of hopefulness.

But because short-interest numbers are about to decrease in the aggregate, it is predictable that, henceforth, short-covering will have less and less power in bull markets and bear markets. In the coming bear market (which my technical runes suggest may already have begun), we are likely to see downtrends that are more relentless than in the past, and sucker rallies that are not quite powerful or persuasive enough to keep hopeful losers in the game.

For now, though, as the big players attempt to shrink their short positions, their efforts will remain fully exposed and vulnerable to raids by the mob. The result will be wack-a-mole rallies in overly-shorted stocks for the foreseeable future. This will continue even as the stock market moves deeply into bear-market territory. However, the rallies will be isolated and add little boost to the broad averages. They may even act as a psychological depressant, a nagging reminder that global securities markets were never more than a giant casino game to begin with.

We’ve been using a 285.16 price objective for months, but it is not even a ‘D’ target, just the secondary pivot of an unambitious pattern that projects to 297.18. It has been a long slog — one not particularly well suited to naked-call strategies. A perfectly timed bet on Aug 28 280 calls would have made you a few bucks, but not much more. As always, the key was to have taken off half of the position after the options doubled in price early on.  The ride to 285.16 from here is a no-brainer, and DIA could eventually make it to 297.18, but I have no simple option strategies to recommend. Here’s one that sounds harder to do than it is — a call butterfly centered on the 295 strike:  Buy the Oct 2 295/300/305 ‘fly for around 0.20. This implies shorting two 300 calls and buying a 295 call and a 305 call for a net debit of 20 cents ($20). The most you can lose is $20 per spread, but if the stock is trading near 300 at expiration, you could make as much as $500 per spread (although $260-$320 would be more realistic).  Work out the value of the options in this position with DIA trading at various prices between 250 and 350 if you want to understand exactly how butterfly spreads work.

You could also do a ‘rolling’  calendar spread, buying Oct 16 300 calls for 1.25 while shorting Sep 4 300 calls against them for 0.10. When the latter expire, you would short Sep 11 calls; then, the next Friday, Sep 18 calls. If DIA continues to move higher, the premium you would take in for each successive short sale would continue to increase. Ideally, DIA would be trading for around 300 on Oct 16, and the premium you’ve received for shorting 300-strike calls against them in calendar succession will exceed what you paid for the Oct 16 300s. You will own them for a net credit, that is, with no loss possible and a gain equal to their value. It is a very low-risk way to play a stock that is moving slowly toward a target you are confident in. _______ UPDATE (Aug 25, 8:10 p.m.): Any reports?  I’ll need to hear from at least three subscribers to determine whether to establish a tracking position. ______ UPDATE (Aug 26, 1022 p.m.): Nothing doing, it would seem.

A 228.44 downside target I’d sent out the night before caught Thursday’s V-shaped low precisely. I’d proffered trading instructions as well, enabling some subscribers to buy call options at the exact bottom of an 846-point Dow rally.  Those who reported getting aboard in the Rick’s Picks Trading Room used different strategies, so I did not establish a tracking position. However, using the ‘rABC’ entry tactic I’d explicitly advised could have produced a gain of as much as $34,000 on four round lots. Those who bought options instead would have doubled their money easily, although some of the expiring out-of-the-money calls traded for as much as seven times what they’d fetched in the early minutes of the session.

I put DIA back on the touts list because some subscribers who follow the broad averages were keen to trade an equity-based vehicle rather than E-Mini S&P futures. The opportune timing of DIA’s return to the list was not a coincidence. I had dropped it for a while because it went all boring on us, but brought it back in conjunction with bearish developments earlier in the week. If you are among those who said they wanted DIA back on the list, I’d suggest tuning to the chat room and monitoring my tout updates diligently to make the most of it. Speaking of which, DIA is bound for a minimum 237.59, whence you can expect a tradeable pullback. I am not putting out a trade a day in advance, however, since that Hidden Pivot resistance coincides with  a technically important peak at 237.50 that unfortunately will attract all the yo-yos. Here’s the chart. ______ UPDATE (May 15, 8:39 a.m. EDT): Forget the chart, since index futures are down sharply ahead of the opening — sufficiently so to take out the point ‘C’ low of the target pattern. Perhaps the other shoe has dropped?