Dranger Capital Management's Trading Strategy In Full Swing

Dranger Capital Management's Trading Strategy In Full Swing
By: Angel Reyes

Investors this week used the options markets in an effort to protect against a market sell off. As our readers know, Dranger Capital Management ("DCM"), has been way out in front of this trading strategy as evidenced by its #2 ranking on Barclays.

Trading has been heavy in the S&P 500 ETF where traders bought twice as many put options than calls. Such a strategy, one that DCM employed throughout this summer, points to the possibility of the S&P falling off its recent highs.

DCM continues to follow its proprietary trading strategies to make money for itself and its clients with little more risk than general market risk.

Call today to talk to our CEO and portfolio manager Tony Rigas 866-460-3147, or send an email for more information to trigas@drangercapital.com .

Traders Position Themselves for S&P 500 Pullback
By ED WELSCH

Investors used the options market to buy protection against the possibility of a broad market pullback, a day after the four-week summer rally showed signs of sputtering.

Trading was fairly heavy in the S&P 500 ETF, where more than twice as many put options traded than calls, according to Track Data. The strong activity in puts, which give the right to sell the fund, suggested trading was focused on the possibility of a downdraft in the Standard & Poor's 500-stock index.

"This is clearly a sign of people running for cover and for some protection," said David Gompert, senior market analyst at TradeMonster. Put trading starting to pick up in September contracts also showed traders were getting cautious about the market going into the fall months, Mr. Gompert said, which have historically been "brutal" for the stock market.

One strategy traders pursued to protect against a market correction is called a "1-by-2 put ratio spread," and was seen Tuesday in third-quarter SPY put options, said Steve Claussen, chief investment strategist of OptionsHouse LLC.

Quarterly put options expire at the end of the month rather than midmonth like standard options. About 62,000 third-quarter SPY puts traded at the $90 strike and 31,000 traded at the $95 strike, which roughly correspond to 900 and 950 on the S&P 500.

In that trade, the investor sells twice as many puts at the lower strike to finance buying puts at the higher strike. In effect, the trade breaks even if the S&P 500 falls between 950 and 850, with a "sweet spot" at 900. That level corresponds with the predictions of some of the more bearish market strategists who expect a pullback to where the S&P 500 was before its earnings-season rally, as opposed to the more bullish consensus of strategists expecting the S&P 500 to end the year above 1000. The S&P 500 index closed Tuesday at 989.67.

More put trading that may be tied to macroeconomic worries also took place in shares of children's clothing maker Gymboree, with 25,000 puts trading against 5,000 calls.

The bulk of the action was in September $40 puts, which traded for $2.70 each and break even at $37.30. Gymboree shares closed down 1.4% at $39.82 on apparent anxiety before the retailer's second-quarter earnings report, which is expected after the market close Wednesday.

Sentiment around Gymboree, which sells items like backpacks and lunchboxes as well as clothes, may be suffering from weak expectations for the back-to-school shopping season.

Despite near-term worries reflected by the defensive maneuvers in the options market, the broader market action showed traders were still optimistic about the chances of economic recovery, with the S&P 500 and Dow Jones Industrials retracing some of their losses from Monday and Friday; both indexes finished the session up 1%.

One outsize, long-term options trade Tuesday also likely reflected a strong optimism over an eventual recovery: more than 30,000 $15 call options traded in Wisconsin-based manufacturer Manitowoc, which closed at $6.66 Tuesday. The success of Manitowoc's construction cranes and commercial-kitchen-equipment manufacturing is tied strongly to an increase in capital investment that would come with an economic recovery.

The catch is that the options traded in longest-dated January 2011 contracts, and only break even if Manitowoc shares more than double from their current price over the next 18 months.

"They are going out as far as they possibly can in time," Mr. Claussen said of the traders making the bet on Manitowoc, "which maybe says they think a recovery is coming -- they're just not sure when."

Write to Ed Welsch at ed.welsch@dowjones.com

Printed in The Wall Street Journal, page C5

Futures trading involves significant risk and is not suitable for everyone.

DCM Correlation

I recently came across an article that bears directly on our trading strategy here at Dranger Capital Management (DCM). As many readers know, our strategy remains bearish on S&P 500 with both short and medium term holding periods. The strategy follows some basic market principals and incorporates the VIX and overbought/oversold indicators to accomplish above-market returns with little more risk than market risk. See our current rankings in Barclays.

As the author below notes, two factors have made important contributions to stock market returns following recessions. The first is valuation. Depressed valuations typically produce above-average returns going forward for 7-10 years. The second factor that drives market returns “following U.S. recessions is: prospective GDP growth. Each quarter, the U.S. Department of Commerce releases an estimate of what is known as "potential GDP," as well as estimates of future potential GDP for the decade ahead. These estimates are based on the U.S. capital stock, projected labor force growth, population trends, productivity, and other variables. As the Commerce Department notes, potential GDP isn't a ceiling on output, but is instead a measure of maximum sustainable output.

The comparison between actual and potential GDP is frequently referred to as the “output gap.” Generally, U.S. recessions have created a significant output gap, as the recent one has done. Combined with demographic factors like strong expected labor force growth, this output gap has resulted in above-average real GDP growth in the years following the recession.” Unfortunately, we’re not seeing an output gap. Indeed, we’re not sure this recession is over.

Bottom line: “Aside from a gradual recovery of the "output gap" created by the current downturn, there is no structural reason to expect economic growth to be a major driver of investment returns in the years ahead. With valuations now elevated above historical norms, there is no reason to expect strong total returns on an investment basis either.”

As we’ve noted several times in the past few months, the single market driver is speculative and program buying. Everyone is hoping the recession is over and failing to look at the fundamentals that underlie this current recession. Overpriced stock and an output gap would be a natural place to look if one we’re of the opinion that the recession is over and U.S. stocks will again begin a sustainable ascent. DCM isn’t seeing those fundamentals, so we’re positioning ourselves to take advantage of our insight. At DCM , our trading
record speaks for itself, see our latest rankings in Barclays.

See the full article below:

Growth in "Potential GDP" Shows Limited Potential

By John P. Hussman, Ph.D.

Historically, two factors have made important contributions to stock market returns in the years following U.S. recessions. One of these that we review frequently is valuation. Very simply, depressed valuations have historically been predictably followed by above-average total returns over the following 7-10 year period (though not necessarily over very short periods of time), while elevated valuations have been predictably followed by below-average total returns.

Thus, when we look at the dividend yield of the S&P 500 at the end of U.S. recessions since 1940, we find that the average yield has been about 4.25% (the yield at the market's low was invariably even higher). Presently, the dividend yield on the S&P 500 is about half that, at 2.14%, placing the S&P 500 price/dividend ratio at about double the level that is normally seen at the end of U.S. recessions (even presuming the recession is in fact ending, of which I remain doubtful). At the March low, the yield on the S&P 500 didn't even crack 3.65%. Similarly, the price-to-revenue ratio on the S&P 500 at the end of recessions has been about 40% lower than it is today, and has been lower still at the actual bear market trough. The same is true of valuations in relation to normalized earnings, even though the market looked reasonably cheap in March based on the ratio of the S&P 500 to 2007 peak earnings (which were driven by profit margins about 50% above the historical norm).

Stocks are currently overvalued, which – if the recession is indeed over – makes the present situation an outlier. Unfortunately, since valuations and subsequent returns go hand in hand, the likelihood is that the probable returns over the coming years will also be a disappointingly low outlier. In short, we should not assume, even if the recession is ending, that above average multi-year returns will follow.

That conclusion is also supported by another driver of market returns in the years following U.S. recessions: prospective GDP growth. Every quarter, the U.S. Department of Commerce releases an estimate of what is known as "potential GDP," as well as estimates of future potential GDP for the decade ahead. These estimates are based on the U.S. capital stock, projected labor force growth, population trends, productivity, and other variables. As the Commerce Department notes, potential GDP isn't a ceiling on output, but is instead a measure of maximum sustainable output.

The comparison between actual and potential GDP is frequently referred to as the "output gap." Generally, U.S. recessions have created a significant output gap, as the recent one has done. Combined with demographic factors like strong expected labor force growth, this output gap has resulted in above-average real GDP growth in the years following the recession.

The chart below shows the 10-year growth rates in actual and potential GDP since 1949 (the first year that data are available).

The blue line presents actual growth in real U.S. GDP in the decade following each point in time. This line ends a decade ago for obvious reasons. The red line presents the 10-year projected growth of "potential" real GDP. This line is much smoother, because the measure of potential GDP is not concerned with fluctuations in economic growth, only the amount of output that the economy is capable of producing at relatively full utilization of resources.

One of the things to notice immediately is that because of demographics and other factors, projected 10-year growth in potential GDP has never been lower. This is not based on credit conditions or other prevailing concerns related to the recent economic downturn. Rather, it is a structural feature of the U.S. economy here, and has important implications for the sort of economic growth we should expect in the decade ahead.

The green line is something of a hybrid of the two data series. Here, I've calculated the 10-year GDP growth that would result if the current level of GDP at any given time was to grow to the level of potential GDP projected for the following decade. This line takes the "output gap" into effect, since a depressed current level of GDP requires greater subsequent growth to achieve future potential GDP. Notice here that even given the decline we saw in GDP last year, the likely growth in GDP over the coming decade is well under 3% annually - a level that we have typically seen in periods of tight capacity (that were predictably followed by sub-par subsequent economic growth), not at the beginning stages of a recovery.

The situation is clearly better than it was at the 2007 economic peak, where probable 10-year economic growth dropped to the lowest level in the recorded data, but again, the likely growth rate is still below 3% annually over the next decade even given the economic slack we observe.

Aside from a gradual recovery of the "output gap" created by the current downturn, there is no structural reason to expect economic growth to be a major driver of investment returns in the years ahead. With valuations now elevated above historical norms, there is no reason to expect strong total returns on an investment basis either.

The primary element that is favorable at present is speculation – excitement over the prospect that the recession is over. Investors are presently anticipating the good things that have historically accompanied the end of recessions (strong investment returns and sustained economic growth), without having in hand the factors that have made those things possible (excellent valuations and a large output gap coupled with strong structural growth in potential GDP).

Persistant Market Manipulation

The persistant computer program buying continues to push prices upward and create an extremely overbought environment. The market internals are painting a different picture about the continued sustainablitity about this move. Four times in the last 14 trading days, the S&P's have gone up 1% or more, with the volume being lower or only marginally better on the NYSE versus the previous day.

Looking at the volume totals on Tuesday 8/12 shows an even uglier picture. The market breadth was extremely weak with decliners surpassing advancers by more than 2.5 to 1. Meanwhile, the market finished up close to 1%.

As we move into the fall, we think the volatility will increase further, and we continue to believe that the probabilities of further price appreciation from here are extremely limited, and favor remaining short.

Extremely Overbought

The market continues its aggressive move upward without taking a moment to catch its breath. We have had postive months posted since March, which is not normal. The DJIA has rallied as of this a.m. 43% since March '09, while the Nasdaq has gone up over 57% in the same time frame, a pretty impressive move indeed.

We view this situation of 5 positive months in a row as a once in a 75 year occurance and see the market as very overbought. This overbought environment can continue longer (as it did with the Nasdaq in 1999-2000), nothing is impossible. However the higher it goes in this manner, the more painful the return to normalicy will be. In other words, the higher it goes without a correction, the harder the fall will be. That's historically the pattern, not to mention using some common sense.

Additionally, the economic reports coming out and the corporate earnings being reported, have been better than the previous reports on the whole. Things have gotten less bad. But look at what the comparisons numbers were - they were weak to begin with.

Once last thing to consider. There has been an overwhelming Bid to the market, particularly in the last two weeks. All buy programs present. The selling programs, for whatever reason, have not been present. We see them as taking a rest, not extinct.