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FISHBACK MANAGEMENT & RESEARCH
P.O. Box 23798, Lexington, Kentucky
(December 18, 1997) FINANCIAL INSTRUMENTS: MARCH BOND AND NOTE FUTURES–As noted last week, gold was at a very critical juncture. And based on the latest price action, it may have put in an important bottom this week. One of the things that we monitor is a tendency for the market to drop to a low level, then fall even lower and then reverse course and finish higher on the week on rising volume. That is called a selling climax, and it happened in gold stocks last Friday when the XAU (gold/silver stock index) finished above its close of Friday, December 5. Plus gold itself bounced off of very long-term support at 285. This is a bit of a problem for bullish bond traders, as gold has suffered and bonds have benefited from the notion that inflation was dead. If gold were to now rally because the market senses that inflation is not dead, then bonds may begin to suffer. We'll have to see how this plays out the next couple of weeks.
Right now, despite the XAU's selling climax, you still have to give the benefit of the doubt to the bond bulls. Short, intermediate and long-term price trends in bonds are all higher. The only thing that bond bears seem to be able to muster is a slight sell-off that still has the market higher than it was a week ago. Plus sentiment looks pretty good. The survey data show no signs of excessive optimism towards bonds. And the bond put/call ratios look okay. Also gold put/call ratios are indicating that this recent rally attempt was very much anticipated by the usually wrong crowd. That is, this may be nothing more than on oversold bounce in gold. If that is the case, bonds are likely to head higher after this period of consolidation.
The key here is volatility. We need it. We got a little bit last week. We need more. (If the market heads higher, we need just a little more volatility to turn this into a risk free, unlimited profit trade. If bonds head lower, we'll need a lot of volatility to the downside.)
RECOMMENDATION–No new recommendation this week. We are holding a bond strangle (buy the March 120 call, buy the March 118 put) purchased two weeks ago at 2-58/64. That strangle is now worth 2-38/64, down 20/64 since out purchase. We are also holding a Match T-note 111 straddle that we purchased three weeks ago at 2-20/64. That position is now worth 2, down about 20/64. Like I said last week, we'll be watching these positions closely, as the options we own will start to run into time decay problems if we are not out of them in the next few weeks.
The key is having enough time for a catalyst to come along and propel prices sharply higher or sharply lower. Based on the way the options are priced, it looks like we'll have a few more weeks before we have to think about cutting out losses if the market remains quiet.
Don Fishback
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