Thursday, July 28, 2011

Possible US Debt limit plays

Disclaimer: NONE of the following is advice for anyone. Its merely an exercise in different choices and available options for current events and theorizing what ifs. I currently have no plans to initiate any of the following.

I'm getting hard wood floors put into my home this week. Everything is moved and out of place and life has been tossed into the air. My time to make videos has been limited but I did want to talk more on the U.S. debt limit as a few commentors requested updates as things develop.

So here we are Thursday 7-28-11. 3 work days before the U.S. debt limit is reached. Everyone seems to have an opinion and plan as to the future of the entire world economy if the limit is not raised. Is this the doomsday event that sends us all into the dark ages again? Is this just much ado about nothing?
As I mentioned I don't want to make predictions but I do want to have plans for what ifs.

If the limit is raised then the Model Portfolio will proceed as normal.
The $150 in the trading account would be re-allocated $50 back to Savings and the $100 to Investing as was planned to continue Phase 1. No harm no foul in the long run with the portfolio.

If the limit is not raised on August 2 what is the likely event that would happen? Well its not like all payments are due on August 3rd.  Bonds are paid monthly and some government organizations get budgets front funded so they have time to keep operating.  There would be few people not getting paid and the federal government would have a bit more time to make a deal.
The impact will be to the image of the stability of the U.S. ability to pay its debts.

U.S. Treasury bonds would more then likely take a hit as people sell to get away from bonds that might not get paid on. Where would they put their money?
There are 4 main categories where your average person has their money: Cash, Bonds, Stock, Precious Metals. There are a lot more but I am talking about generalities and massive amounts of money in overall markets.

If people sell bonds and just sit on cash there isn't much of a play open to me to take advantage of short term other then the Forex but I am not ready to place money into that. It will be interesting to keep an eye on the EUR/USD pair though as this all unfolds. Even in extraordinary times I do not want to take on the risk of my own inexperience and lack of knowledge. I could be right and do something wrong and lose money. That is a very real risk that many do not think about.

The theory so far is people are leaving U.S. Bonds so we'd want some put options on those bonds. These put options would increase in value as whatever they are tied to drops in value. Lets use the TLT etf which covers 20 year US Treasuries. Options expire on the third Friday of the month. We could go with August options but would only have about 2 weeks before they expire. Before that time, their value drops pretty sharply because of this deadline limit. Would any move in the markets move that fast? The markets perhaps but the government no. I want to look at Sept options

TLT Sept 92 PUT @ $1.22
I know I haven't covered options yet and I said I would try not to bring up topics without talking about them but time is a bit short. I will cover options more in the future.
If I were to buy this option it would give me the right, but not obligation to sell (because its a PUT option) 100 shares (the number of shares in 1 option contract) of the TLT etf for $92 each to whomever sold me this option. The $1.22 price is per share in the contract so to buy 1 option it would cost my account $122, almost all the trading money. I'm not sure if I like that part.
Since I do not have 100 shares of TLT to sell I need to sell this option in the future but since this would be a trade that is fine.

TLT is nearly at $96 right now and hasn't been under $92 since April. In June we have some support around $93-$94 range so we have that fighting against this trade.
The "open interest" of an option is how many option contracts are out there. For this Sep 92 PUT, there are 2,300 contracts owned out there by others. With lower open interest there are less investors and less money involved which would make it harder for me to get out of the trade if I were to get in it. Perhaps there is something else that I can get into with more liquidity. I ALWAYS want to be able to get out of a trade when I want to. Believe me, its rough being in a trade trying to get out and nobody is taking the other side.

TBT Sep 34 CALL @ $0.9
TBT Sep 35 CALL @ $0.84
TBT is a x2 ultra short version of TLT. These means that it will move in the opposite direction that long term US treasuries move. I could buy a CALL option which increases in value to whatever its tied to.
In this case people sell bonds, TLT drops in value, TBT increase in value by double that amount, a call option of TBT would also increase in value.
Its a bit cheaper and wouldn't take all my trading money. The open interest is 15,000 for the 34 and 34,000 for the 35 option. That's a better open interest level but bonds usually don't move far very fast and I have a time limit here.

Precious Metals
There is another play available to me. If people sell bonds where would they place their money? Precious metals is a good play when fear is high. Not many things are more fearful then the U.S. collapsing. Note I do not think the U.S. is going to collapse but the markets could think so temporarily.

I do not want to buy actual gold for a trade because it would take weeks for delivery. Then when I sell I have to find someone that wants to take a pile of metal from me. So I will need to stick with ETFs here.
GLD is a gold etf but its options are going to be way too expensive for the amount of money I have currently available. I could buy options that are really far away from the current price of GLD but the further you go out the less likely you have of the share price getting to your point.

Silver is a good alternative...
SLV Aug 40 CALL @ $1.26
SLV Sep 42 CALL @ $1.33
The interest here is only 2,500 for the Sep option. Aug has 37,000 but that is getting close to expiration. Everything else is getting pricey.

ZSL Sep 12 PUT @ $0.9
ZSL is a x3 short of silver. Remember how I mentioned in my video that I don't want a lot of complex moving parts to a trade? For this trade to work people sell US treasury bonds, then put their money into silver, silver rises in price so ZSL drops by x3 that amount, since this is a put option the option increases in value.
If you are confused don't worry, this is just a ridiculous trade. The fact there are only 200 options in open interest should tell us that the rest of the world thinks this is a bit silly too

What about the stock market? The S&P500 has tried 3 times recently to break above 1350 how much more effort can it have left? The US government fears could easily push it on down. It seems the stock market freaks out over anything.

SDS Sep 22 CALL @ $0.86
SDS is a x2 short of the S&P500. I like that price and Sept gives us an extra month to see what develops. $22 was the price back in June and appears to be the resistance level. Open interest is over 11,000 so lots of liquidity there. This also helps hedge my O investment if that were to fall in price with stocks in general.

The SDS play probably is what I would consider. In all honesty though guys I see maybe a 10% chance of me actually doing this. Something major would have to happen like all negotiations stop or they keep trying to work on multiple plans on Monday Aug 1st. They could make an agreement at 11:59 pm Monday when markets are closed. I would be stuck in a trade I made on Monday. That is some very big risk to consider.

I am perfectly happy sitting back. At this early stage of the Model Portfolio I want to build up the account through deposits and my rules state my account must grow each month.
A month ago I wouldn't have even seriously considered these trades but the government seems to be messing around on this topic. If nothing else we can look back on this entry and see what happened with the option values. The research and experience gained from this exercise in theory could be more valuable then any actual dollar gains.

Disclaimer: The investments and trades in my videos and blog entries are not recommendations for others.
I am not a financial planner, financial advisor, accountant, or tax advisor. The financial actions I talk about are for my own portfolio and money and only suited for my own risk tolerance, strategy, and ideas. Copying another person's financial moves can lead to large losses. Each person needs to do their due diligence in researching and planning their own actions in the financial markets

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