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Make Up to 132% on What Could be the Safest Investment in the Next Bear Market
By now, you've probably heard the story. Someone hacked the Associated Press's Twitter account and sent a false report of an explosion at the White House. Stocks sold off on the original tweet with the Dow Jones Industrial Average falling more than 100 points in less than two minutes. The rebound came just as quickly as traders bought when the report turned out to be fake.
The crash lasted less than three minutes and the market completely recovered within 10 minutes. A one-minute chart of SPDR Dow Jones Industrial Average (NYSE: DIA) is shown below.
There are a lot of questions about how this mini-crash could happen. Traders have known since at least 2011 that hedge funds are mining Twitter for trading ideas. These funds can use high-frequency trading strategies to buy and sell based on what the computers are seeing on Twitter. This crash seems to have been an example of how quickly these strategies can respond, and it demonstrates that there might not be any human intervention in the markets, at least in the initial moments after news hits.
This crash also allows us to draw a few insights into what traders will do if there is a significant news event. They will sell stocks, as the chart of DIA above shows.
We ran through the one-minute charts of a number of ETFs to see how they fared and discovered that almost all ETFs declined and recovered quickly. This isn't surprising because cross-asset correlations tend to rise in a sell-off.
When traders say correlations rise in a sell-off, they mean that almost everything in the world falls during a bear market. We saw this in 2008, when U.S. stocks declined along with stock markets all around the world. Only 3 of 19 asset classes were up in 2008, according to research done by Callan Associates.
Callan does not include gold in their report, but SPDR Gold Trust (NYSE: GLD) did show a gain in 2008. It also delivered a small gain in the Twitter crash, although it was quickly reversed.
The standout investment during the three-minute crash was CurrencyShares Japanese Yen (NYSE: FXY). This ETF jumped more than 2% in three minutes.
Strength in the yen like we saw in the crash is surprising. Japan has embarked on a massive quantitative easing program that could double the supply of yen before the end of next year. Increased supply should reduce the value of an asset, according to economic theory, and over the past few months, the yen has been falling while Japanese stocks have been moving higher.
In a crash, and even under normal market conditions, traders are not always rational, and they could be turning to the yen as a safe haven in this specific case. The false news alert indicated there had been an explosion at the White House. Dumping dollars to buy yen could have been the best trade for this specific scenario, or it might indicate traders expect Japan to offer some certainty over the next few years.
Japan has announced its intentions to double the money supply while central bankers in the United States and Europe are forcing traders to guess how they will respond to future events. Traders prefer certainty to uncertainty, and Japan may be the new "risk off" trade.
We believe that the crash offered a long-term trading idea. For that moment, traders viewed Japan as the safest place to invest. Buying the yen might seem like a contrarian trade, and it is. Traders can buy either FXY or take advantage of the fact that long-term call options are cheaply priced.
According to an options pricing model, calls with a strike price of $95 expiring in January 2015 should be priced at about $9.94, more than 10% above the recent price of $9.
Value investors look to buy when the market price is below fair value as it is on the FXY option. FXY is a contrarian trade, but one that could do well if there is a bear market sometime in the next year and a half.
Recommended Trade Setups:
-- Buy FXY below $100
-- Set stop-loss at $90, a support level from 2008
-- Set price target at $117 for a potential 17% gain in 18-20 months (this price is the 61.8% retracement from the 2011 highs)
-- Buy FXY Jan 2015 95 Calls for $9.50 or less
-- Set stop-loss at $5
-- Set price target at $22 for a potential 132% gain in 18-20 months