Play for an Inflation 'Hangover'

The stock market likes a little inflation -- for a period of time, anyway -- because it's impossible to for a country to realize economic growth without allowing its money supply to grow along with the demand for its currency. The more currency in the system, the more it tends to move toward the stock market (to a point). Thus, inflation should more or less grow at the rate that a country is prospering and its population is growing. Too much currency floating accompanied by not enough goods, resources and services offered (because demand for them is rising) will cause inflation. (Sort of makes you not want Uncle Ben's job, doesn't it?)

Milton Friedman made the analogy of inflation to alcoholism, writing that when beginning to drink, say, a good wine (my analogy), things will go fine. But keep drinking more good wine, and you'll be in for a serious hangover! We the people were served a rather large amount of "good wine" last month, when the November PPI and CPI came in at 0.8% and 0.1%, respectively. When I first saw those numbers, I made a mental note to be on guard for a possible trend beginning. Thus, when the December PPI and CPI numbers are announced on Thursday and Friday respectively, I think that the "wine party" that began a few months ago might enter the "hangover" phase -- and a new trend phase. The PPI for December is projected to be 0.8% and the CPI is projected to 0.4%! Ladies and gentlemen, strap yourselves in because the "Big I" is possibly here again, and the party has only just begun!

When I first began to actually make money in this business, I was taught to never annualize any positive return on any trade, or combination of trades, or even successful months after months! Thus, no matter how well I was doing, I never multiplied anything by 12 (thereby annualizing it). I still don't! However, when examining economic numbers reported by the U.S. government, keeping to that rule should be given a pardon as our government tries its best to paint a pretty picture in regards to our cost of living. For example, many years ago the PPI and CPI were not "watered down" by the current process of the government extracting "food and energy" costs from these inflation figures. When forced to report what they must, you should note the report with an inquiring mind. Reporting an "annualized" 9.6% PPI and an "annualized" 4.8% CPI should catch your attention and alert you to the possibility of making a buck -- or a lot of them -- by trading ahead of these numbers in a way that uses the projected PPI and CPI reports to your potential trading advantage.

Bonds HATE inflation! We know that. Bonds have already signaled that they are beginning to feel the "wine," as they swooned lower in price over the past few months. Bill Gross has told the bond world to be ready for lower bond prices in the months and years ahead. And Uncle Ben's quiet QE2 strategy is tied to forcing "mattress money" out of bonds and back into equities. Higher inflation could catalyze that monetary rotation.

With a potential bond whacking thanks to eye-catching PPI and CPI reports just ahead, and options in the ProShares UltraShort 20+ Year Treasury Bond Fund ( ( TBT); $38.34 at the close Friday) available to trade, consider a speculative call purchase in TBT.

Trade: Buy to open 5 TBT January 38 calls for $1.00.

These calls expire on Friday, Jan. 21, which means the timing for this trade is tied to a potential poor reaction by the bond market to the upcoming PPI and CPI reports. Thus this trade is highly speculative, and it's one where you could lose 50% to almost 100% of your capital allotted to the trade in minutes!

This trade also requires your full attention, as the exit price for the trade must be managed so as to part with the calls once the reactions to these reports has been expended. That could be as early as Thursday or as late as Friday afternoon.

You might want to read my previous TBT trades. As always, I will be monitoring this trade in the comments section below.

At the time of publication, Raschke had no positions in the securities mentioned.

Skip is a former registered options trader and member of the Philadelphia Stock Exchange. He was an equity options analyst and broker with Paine Webber and a proprietary trader for Van Der Moolen. He served in the USMC, as well as played minor league baseball with the N.Y. Yankees organization. He is an independent stock and options market consultant.

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