June 15, 2016, 4:30pm EST

The Fed held rates steady today.  As we’ve talked about, this was a decision they laid the ground work for over the past two weeks.  We want to talk about a few takeaways from the Fed event, and then continue our discussion from yesterday on the Bank of Japan decision tonight (where the big news may come).

First, the Fed did indeed consider the global stability risk that comes with the decision in the UK on whether or not to leave the European Union.  The polls in recent weeks have continued to show that it could go either way.  Meanwhile, the bookmakers have had this vote clearly in favor of “staying” in the European Union all along — as much as 70/30 ‘stay’ much of the way.  But those odds have been narrowing in the past week.

Still, as we discussed yesterday, holding pat on rates today was a “no risk” decision, especially because they had an event (the weak jobs data) and the platform (through a prepared speech by Yellen just days after the weak jobs data) to manage away expectations for a hike.

With that, stocks remained steady on the decision.  And markets in general remained tame.

So now the Fed is in position to see the outcome in the UK.  There was some two way talk about the jobs and inflation data, but it looks like the Fed is most concerned with what’s going on in the global economy.  That’s clear in their reaction to the oil price bust, when they responded back in March by taking two rate hike projections off the table.  And it’s clear in their reaction now to the Brexit risk.

But their new projections on the future path of interest rates have been ratcheted down in the coming years, and in the long run.  For perspective, a year ago the Fed thought the benchmark rate would be 2.75%.  Now they think it will be 1.5.  Why?  What’s been acknowledged more and more in recent meetings is the impact of the weakness and threats in global economies on the U.S. economic outlook.  The U.S. economy has been relied upon to drive global economic recovery, but it’s being dragged down now by the weight of global economic weakness.

This all puts pressure on Europe and Japan to follow through on their promise to do “whatever it takes” to restore their economies.
As we’ve said, the most important spots in the world, right now, are Japan and Europe.  The Fed only began its campaign of removing its emergency level policies because Europe and Japan took the QE baton handoff from the Fed – picking up where the Fed left off.  And unlike the U.S., which is constrained by “flight to safety” global capital flows and a world reserve currency, they have the ingredients (primarily Japan) to make QE work, to promote demand, to promote growth.  Japan has the largest government debt problem in the world. They have an undervalued currency.  They have a stagnating economy with big demographic challenges. They have are in a deflationary vortex.

They have the perfect attributes for a mass scale currency printing campaign. Not only can it work for their domestic economies, but it serves as the liquidity engine and stability preserver for the global economy.

In normal times, the rest of the world wouldn’t stand for a country outright devaluing their way to prosperity.  But in a world where every country is in economic malaise, everyone can benefit – everyone needs it to work. It can be the solution for returning the global economy to sustainable growth.

With that, and given the position of the yen and Japanese stocks (see our chart yesterday), along with the underperforming economy in Japan, even after three years of QE, now is the time to throw the kitchen sink at it (i.e. they should act tonight, and in a ‘shock and awe’ fashion).

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First, let me say this: Most people lose money trading options.

It’s a very difficult game. But if you can find an edge, the returns can be huge. One of the best option-trading hedge funds in the business, Cornwall Capital, has averaged 51% annualized over the past 10 years. That turns a mere $20,000 investment into $1.2 million, in less than 10 years.

Two of the best option strategists that have ever worked on Wall Street are Keith Miller, formerly of Citigroup, and John Marshall, of Goldman Sachs. Both Miller and Marshall happen to be Blue Jays (i.e., Johns Hopkins University grads), like me. If you can ever find any of their research studies, print them out and examine them closely. They are excellent — and will give you an edge.

Below are the rules the best hedge funds use when trading options:

Rule #1

Options are like a coin toss; you’ll be lucky if half your option trades are profitable. That is why you have to make sure you get paid for the risk you take.

Only trade an option if your projected return is a triple or better. To do this you will have to buy an out-of-the-money option. And you should go out at least two months, preferably longer. Now, here’s the math:

Let’s say you make 40 option trades a year. Odds are at best you will only make money on 50% or half of these trades. Therefore, if you had 40 options trades and 20 of those trades expired as worthless, and the other 20 option trades averaged a triple or more, you would still make 50% a year. For example, on a $40,000 account taking 40 trades a year, if 20 option trades lose everything and the other 20 trades give you an average return of 200%, your account would be worth $60,000, giving you a 50% return.

So $20,000 would go to zero on the option trades that expired worthless. The other $20,000 would go to $60,000 on a 200% return.

Rule #2

Price predicts a stock’s earnings and fundamentals 90% of the time. According to Keith Miller of Citigroup, a stock will start to move one to two months ahead of its earnings date, in the direction of the earnings report. This means if a stock starts trending higher or breaks out higher before the company reports earnings, the earnings report will be positive 90% of the time.

Rule #3

When you are buying options on a stock, make sure the stock is owned by an influential investor or activist. These investors, such Carl Icahn, Barry Rosenstein of Jana Partners and the rest, are always working behind the scenes to push the companies to unlock value; this can come in the form of incremental positive change or big one-time catalysts. This positive announcement or catalyst usually emerges after the stock has moved up in price. So when you see an activist-owned stock breaking out, or trending higher, there is usually a good chance change is coming. Thus, you’ll want to buy calls on this stock immediately.

Rule #4

Only trade an option if there is an event or catalyst that will reprice the stock. This could be an earnings announcement, a company’s Investor Day or an annual meeting.

Rule #5

Only buy options when both implied volatility and historical volatility are cheap. Be a value buyer of options. Watch volatility. Buy volatility only when it’s cheap.

A perfect example of an option trade that fits all of the above criteria is Walgreens ($WAG).

> Jana Partners, run by billionaire Barry Rosenstein — one of the top 5 activist hedge funds on the planet — owns more than $1 billion of Walgreen’s stock. That’s more than 10% of the fund’s overall assets invested in Walgreen’s (Jana has $10 billion under management). Even better, they just added to their position last week, buying $77 million more during the market correction.

> Walgreen (WAG) just broke out of a consolidation pattern, and it looks like it is ready to make a big run (see chart below).

> Walgreen reports earnings on December 22nd. So whichever way the stock moves over the next month or two will predict whether the company’s earnings are positive or negative. Based on the stock’s current price momentum, the report will be positive.

> The Walgreen $65 calls are cheap, especially since they expire only two days before the company reports earnings. You can buy the Walgreen December $65 calls for just $1.10. That means, at $66.10 or higher, you will make money on this option. My price target for Walgreen, based on its recent breakout, is $69. That also happens to be where Walgreen gapped previously.

> If Walgreen stock trades just 10% higher to $69 by December 20th, you will more than triple your money on this option in less than two months. This is the risk-reward profile you want when trading options. Your goal should be to make 50% a year.

Will Meade
President of The Billionaires Portfolio

8//27/2014

Over the past week, I received hundreds of emails concerning Carl Icahn’s announcement that he took an 8% position in Hertz (HTZ). We know Icahn has already publicly stated he wants to actively engage with Hertz management and its CEO, but there has been no word about Icahn pushing Hertz to merge or sell itself.

Here is why: First, regulators would never approve a Hertz-Avis merger. The two entities represent too large a share of the industry. It would essentially be a monopoly. So a merger with Avis isn’t happening — at least in my opinion.

Though, given the quick 25% run up in Family Dollar (FDO) last month after Icahn forced a merger with Dollar Tree (DLTR), it’s easy to see why investors are hoping for a similar result. Clearly, people don’t want to miss out on the next FDO. On that note, you can read some great analysis of the Family Dollar deal, where my partner and I predicted the merger and picked the bottom in Family Dollar stock (read that here).

But again, this is not going to happen with Hertz. Icahn and numerous other investors are long Hertz. Hertz is actually one of the most popular stocks owned by top billionaire hedge fund managers, because it’s a pure play on the improving economy, and rental car companies have lagged airlines in terms of raising their prices.

So many hedge funds are betting on Hertz increasing its prices, like the airlines did last year, and they are betting that demand will continue to improve with the recovery in the economy. It’s that simple.

Also, this is not a classic Icahn play. He typically comes into a deeply depressed stock selling near its 52-week low or multi-year lows. Icahn purchased Hertz near the stock’s all-time high.

But what Icahn is doing is playing his “change” card. He has recently laid out his evidence, based on his history as an activist investor, of how replacing a CEO is a powerful catalyst for producing shareholder wealth creation. And one of his fellow shareholders in Hertz is already at work on that strategy: Fir Tree Partners is pressuring the board to oust the CEO.

Will Meade
President of The Billionaires Portfolio