Bear Market Rallies

A broadly accepted definition of a bear market is when the market sells of at least 20% from it's previous highs. The S&P 500 closed 38% from it's previous high set in October of 2007. We are definitely in a bear market and are going to experience bear market rallies.

A bear market rally is when the markets come back 10-20% in a clearly evident down trend. They come suddenly and can last for days on end. After the crash of 1929 there were many bear market rallies, however the general trend was downward and these rallies would fade after a couple days leading to the bottom in 1932. We have clearly been in a bear market rally the past couple of days.

Fundamentally nothing has changed. Investors are showing extreme confidence behind an infrastructure focused stimulus package that President Elect Barack Obama promises to sign. The funds will most likely be focused on clearing the back log of projects that states cannot fund. Prior government efforts to boost the economy by pumping funds in to infrastructure projects have proven to be riddled with problems. Many believe the inefficiencies inherent in government will create a lag time in which the economy will worsen and there is also great concern that projects will run over budget, as they typically do.

As the economy worsens the stock market will have to price in the changes, meaning that after this current bear market rally is over we're most likely heading down in a new leg of sell offs. December will prove to be another tough month for employment, consumer spending, and capital expenditures for companies. We're heading lower, in times like this patience is absolutely key.

DRYS closed up more than 50% today and my puts got obliterated. I'm now looking at paper losses in excess of 80%. I would normally be upset and angry but as I said above we're in a clear downtrend and I can't let a bear market rally make me second guess my research. DRYS rallied off no news specific to the stock, value investors bought this up and shorts were forced to cover, leading to a spectacular day. DRYS is trading like a stock headed for bankruptcy (think BSC, CFC, LEH, FNM, FRE, etc..) which means it's going to see huge swings in both directions. Nothing has changed with the company, so I will hold on to my position anticipating a huge sell off based off horrible fundamentals.

CHK rallied 2.76 points, or 24%, off news that the company would scrap it's 50 million share sale and sell assets worth $4 billion instead while cutting down on capital expenditures. While this is a smart move by the company natural gas continues to sell off. So, they're loosing cash generating assets and are getting paid less for their product. Although I believe the bankruptcy scare is over, it's up in the air when this company will return back to profitability. My puts in CHK got hammered today and I'm showing a substantial paper loss. I'm going to hold on to the puts and wait for the next downward leg in the markets. Although the idea of being profitable on these puts is out the window, at least we can make some of the money back. It will be very interesting to see if CHK can actually stay solvent without substantially diluting their shares - they claim they can but so did Bear Sterns.

Mama said there would be days like this and boy was she right. It's important to note the amount of volatility and risk that is part of this current market. It's also important to stick to strategy in times like this, nothing fundamentally changed today so I had no reason to change my positions. CHK still has hurdles it needs to clear and DRYS hasn't mentioned a thing on how they're going to come out of this alive. It is agonizing to watch your positions lose so much in one day but it's part of the extremely volatile job of trading options. I'm not going to loose any sleep tonight.

Let's see what tomorrow has in store.

-Nik (1/2 of the dynamic duo crazy enough to trade options in this market :).