This morning, as I watched our backyard slowly turn into the swimming pool that my wife wanted to get someday, I spent a bit of time thinking about the market action of the past few weeks. Volatility has been very high and has given me the chance to grab some cheap stocks and sell a few puts on stocks I want to own at lower prices. Listening to the talking heads while going through the papers and morning emails, it occurred to me that in this market everyone has an opinion and no one has a clue. Too many economic and political variables are in play right now for anyone to know how the markets will do over the rest of the year.
Prognosticators are making very confident predictions for the market based on their earning models. I would venture a guess that somewhere in the neighborhood of 99.9% of earnings models will miss the actual end-of-year numbers. Oil and oil services companies will probably miss estimates. So will many retailers and restaurants if the economy does not pick up steam. Anyone who says that they have a definite idea of what the earnings of large banks will be is probably in need of a good long rest. I could take the same data points right now and make a strong case for either the bull or the bear side of things.
The market has had some strong selloffs that allowed me to add cheap stocks. Given the uncertainty in the market, it might be a good idea to have a few short positions here in case the bears win the current global economic argument. In 2007 and 2008, I learned how much one or two small, short positions could help ease the sting of a savage bear attack. Over the years, I've made it pretty clear that I am what you might call a "chicken short". I have never been net short or been outright short a stock that was not part of an arbitrage position. I use put options and put spreads to establish my short positions.
I also never short the really great companies. I might not even own Amazon (AMZN) at these valuations, but it's a great company. Netflix (NFLX) is a different story. I never thought this was a great company, and it had no real buffer to protect its business. Kiosks were attacking the DVD business, and Amazon had planned to get into the streaming movies business.
Earlier this year when the stock was around $300, I said that the shares would see $200 long before they would see $400. Here's an update: The stock will see $100 before it sees $300 again. The company has lost content and raised prices, and I do not think these changes will sit well with consumers. At 55x current earnings and more than 30x, the always optimistic and highly accurate earnings estimate, the stock is just too expensive. It looks like a patient trade could get a trade off in the January put options with a three-to-one, risk-reward ratio in several different strikes.
The other stock I think I will try to set up a bearish option spread in is Buffalo Wild Wings (BWLD). Same-store sales growth is in the single digits, and the company has to rely on new store openings to drive growth. Although the company dodged a bullet with the end of the NFL lockout, I just do not think chicken wings and beer deserve a 25 multiple. In addition, I have a philosophical problem with the stock. Anyone who goes to a chain restaurant to watch the game instead of a locally owned joint should have their fan card revoked. Football is watched at places like Luke's, Red Eyes or Annie's Steakhouse and Sports Bar. It looks like a favorable trade can be established using March 2012 options.
I have no idea which way the market will move the rest of the year. Catalysts exist for strong moves in either direction. I think it makes sense to have a few chicken shorts on right now.