Join The Trading Room

FAZ Shares Offer Carny Game Odds

By Rick Ackerman Posted on May 22, 2009, 12:01 am EDT Last Updated May 28, 2010, 3:24 pm EDT
We scratched a bearish position in the financial stocks yesterday, exiting some options we’d purchased in a vehicle that leverages the downside in the Russell Financial 1000. There were a few reasons why we decided to bail out for a slight profit, even though we’d held the position for just a couple of days. For one, the trading vehicle itself – the Financial Bear 3x, or FAZ, as it is known —  appears to be an unbeatable game, at least for the retail customer.  Before this week, we had never offered a trading recommendation in FAZ even though it seemed to be popular among regulars in  the Rick’s Picks chat room.

faz-is-flushing-money

However, just a few days’ exposure to option premium risk convinced us that FAZ was conceived as a way for professional traders to fleece retail customers. Clearly, FAZ puts and calls are designed to be sold (i.e., shorted) rather than bought. That’s because premium decay is severe, and also because, due to the leveraging factor, slow, steady losses on the customer side are rarely recouped when the options spasm higher on their way to zero.

Weasels…

With this epiphany, we put out the following bulletin Thursday morning in the Touts section of Rick’s Picks:  “Live and learn, as they say.  This vehicle is a chat room favorite, but I hadn’t paid much attention to it myself until we established a small position the other day. And now I know:  FAZ is an unwinnable carny game controlled by some of the sleaziest operators in the business.  We know this because of the way the June 10 calls that we tried to short this morning behaved when financial stocks opened on a phony gap-down. Ordinarily, option market-makers would have used this situation to rape buyers of June 10 calls on the opening by filling buy-at-the-market orders at the highest price possible.

” Instead, there evidently being no market orders or even any enthusiastic bids, the weasels fell over each other lowballing the offer, selling the calls in front of us at a price we could not match.  The result is that the calls opened at 0.22 – not only far less than the 0.30 we had sought, but at a between-markets price that was out-of-bounds for retail customers.  (The public can trade only in nickel increments except on spread orders.)   Considering the foregoing, my recommendation is to scratch the October 10 calls on the current 1.20 bid. Note:  I offered them for 1.25 myself, going between the 1.20/1.30 market reflected at the time, and was filled within five minutes.”

Dollar About to Turn?

There were other reasons we closed out the bearish position, including our expectation of a bullish turn soon in the dollar that could further strengthen financial stocks and put pressure on bullion. Our short-term outlook had called for the Dollar Index (DXY) to fall from above 84 to exactly 80.05, a “Hidden Pivot” target. The target was nearly achieved yesterday when heavy selling brought DXY down 80.37, the lowest price since Christmas.

Another reason we elected to cut and run is that our key bellwether for the financial sector, Goldman Sachs, looks like it is fixing to further terrorize shorts. The stock was much stronger than the  market as a whole yesterday, up as much as $3 intraday when the Industrial Average was off by more than a hundred points. Moreover, Goldman has been exhibiting other bullish signs that we wrote about in an analysis sent out to subscribers Wednesday night: “The stock’s last thrust contained the kind of hidden power that creates buying opportunities. Specifically, the high at 144.86 exceeded two prior peaks – including an ‘external’ at 142.00 from early October – but without getting past a more obvious September 19 high at 144.98…”

Bottom line, even though we see the powerful rally of Goldman Sachs and other financial stocks as the Mother of All Bear Traps, that shouldn’t stop us from trying to profit from the hoax while it lasts. (If you’d like to have Rick’s Picks commentary delivered free each day to your e-mail box, click here.)

Chuck’s Favorite Gold Stocks

In yesterday’s commentary on gold and mining stocks, we shared the very bullish thoughts of our friend Chuck Cohen. As a follow-up, we now offer you Chuck’s short list of favorites. He currently owns some, though not all, of these stocks, and the composition of his portfolio was influenced significantly by his friendship and professional relationship with Jay Taylor, one of the most esteemed gurus in the precious metals world. Below is Chuck’s list, mainly of Canadian-listed stocks. He notes that one could also buy a fund that focuses on smaller companies, such as Van Eck, Oppenheimer or U.S. Global.  Here’s Chuck’s list, along with recent prices and exchange symbols:

EXPLORATIONS: Apex (XAU.TO; $2.29 CDN); Alexis (AMC.TO; $0.54 CDN); ATW (ATW.TO; $0.74 CDN); Detour Gold (DGC.TO;  $12.00 CDN); Mauodore (MAO.V  $1.72 CDN); Moneta Porcupine (ME.TO;  $0.10 CDN); Nautilus (NUS.TO;  $1.31 CDN); Metanor (MTO.TO:  $0.50 CDN); Skygold (SKV.V; $.27 CDN); Timmins (TMM.TO; $0.45 CDN); Golden Arrow (GRG.V).

MIDSIZE: Great Basin Gold (GBG; $1.50 U.S.)

SENIORS: Agnico Eagle (AEM; $56.90); Goldcorp (GG; $36.85)

  • Rich May 28, 2009, 8:51 pm

    FAS & FAZ buy more derivatives than stocks so may have built-in time decay.
    None other than Cramer has been on the bandwagon to ban them. The hedgies use them to maniuplate the market because they buy near the open and close. As ZeroHedge pointed out, they also trend toward zero.
    We’re doing ok with one third cash and long equity positions:
    http://stockcharts.com/def/servlet/Favorites.CServlet?obj=ID3251493

  • Jay May 23, 2009, 3:31 pm

    Thank you Rick and Chris for explaining the odds against winning with FAZ/FAS.

  • TC May 23, 2009, 12:12 am

    When you said:

    “Bottom line, even though we see the powerful rally of Goldman Sachs and other financial stocks as the Mother of All Bear Traps, that shouldn’t stop us from trying to profit from the hoax while it lasts. (If you’d like to have Rick’s Picks commentary delivered free each day to your e-mail box, click here.)”

    I am assuming you mean “the Mother of all Bull Traps”…

    Right?

    I lost a bunch of money on FAZ and I am glad I cut my losses when they got to the point they could purchase a nice car. 🙂

    &&&

    Yes, TC, I did mean bull trap. Nonetheless, bears have trapped just as badly, short-squeezed sinced March 6 and providing perhaps 90% of the buying power of this rally (as they always do, since buying by mere bulls will always be timid and relatively feeble. RA

  • Chris T. May 22, 2009, 4:54 pm

    Rick:

    Thanks for being so forceful in pointing out the fraud that FAZ (and really FAS also) are.
    The Barcley’s paper I referred to earlier did mention it, but who reads those math papers?

    Just to put some numbers to the horrific graph you show, and to illustrate that the “call” FAS is just as bad, here is a concrete example:

    About 1 week ago, at the same time, FAZ was at 4.84 and FAS was at 11.56.
    Investing equal dollar amounts in each, should theoretically keep the position balanced.
    Thus for $1000 per leg, 206 FAZ and 86 FAS would be bought.

    After just one week this $2000 is worth only $1897 (206 @ 5.44 and 86 @ 9.03).
    Thus long=fleece.

    What are your thoughts (you touched on it briefly) on shorting FAS instead of buying FAZ, or, beter yet, buying FAS puts?

    Especially the puts would seem attractive:
    a) the underlying has a built in decay,
    b) one would leverage the leverage?

    Or am I overlooking a trap to either of that as well?

    Again thanks for the post!

    &&&&&

    Chris: My option strategies are nearly always long-premium plays, since retail customers have to jump through a lot of hoops before a broker will let them naked-short puts and calls. The term naked-shorting is meant to sound risky, but statistically and on average, it is far LESS risky than buying puts and calls. The odds hugely favorite net sellers of premium, notwithstanding the inevitability of the inveterate frontspreader getting carried out on a stretcher.

    I employ long-premium strategies knowing that the deck is heavily stacked against the put/call buyer. But I have been able to surmount the odds — only slightly, to be sure — by using Hidden Pivots and applying the knowledge I have gained trading options for 35 years. Taken together, these two factors give me a small edge that has produced consistent profits for those who have followed my recommendations.

    Concerning the FAZ, then, if buying puts and calls is a guaranteed loser for the retail customer, then shorting puts and calls will naturally be a winner. You could probably short FAZ strangles carelessly, almost to the point of recklessness, and make money 90% of the time. However, it is that other 10 percent of the time that can be fatal.

    RA

  • RICK DUDLEY May 22, 2009, 1:00 pm

    When the young hot-shots sell the $16.00 silver calls thinking 15.86 is it, they will be gobbled up like the $8.00 nat gas call sellers were in Feb. 2003. (by JR,and I don’t mean the fictitious oil tycoon).


Exit From This Page Back to Trades