Monoline Mania: MBIA and Ambac Included in the Dash to Trash

MBIA (MBI) and Ambac (ABK) were up 46% and 17.5% respectively as of Thursday's close, on no news. Options activity was florid: volume on many strikes was equal to or greater than open interest. Share volume on MBI was 25 million, compared to a daily average of 4 million; for Ambac, volume was 112 million as against 17 million. The mono-lines have been included in what the Fast Money crowd on CNBC has been calling the “dash to trash,” which began earlier this week, featuring Fannie Mae (FNM), Freddie Mac (FRE) and AIG.

Possible explanations

Sitting in my home office in Connecticut, gathering information from press releases, financial statements, or other public information, I am at a disadvantage to the denizens of Wall Street, the fast and smart money players who no doubt are hearing all sorts of rumors from quicksilver messengers of various types, such as emails, text messages, phone calls and even twittering.

I checked my calendar: We are nowhere near a full moon.

Several days ago I had a phone call from a reporter who wondered if anything had been done about TARP for the financial guarantors - the insurance (or reinsurance) provision introduced into the legislation by Rep Eric Cantor, (R-VA). I told him what I knew and suggested he contact Eric Dinallo, former Insurance Commissioner for the State of New York and extremely well-versed in the issues involved. Perhaps the reporter thought from the amount of blogging I do on the subject that I might have inside information. No such luck. Treasury is pretty leaky and if there was anything out there Charlie Gasparino would have it by now.

The stocks involved are all hard to borrow, favorites of the short-to-oblivion set. Maybe the SEC is going to take another look at the issues presented by DTCC's CNS system. If they did, they might conclude that this system enables naked short-selling during the day. DTCC has explained that naked short selling is a trading strategy and not an issue they concern themselves with. If a rumor got out that the SEC were going to do something along those lines, obviously anyone who was naked short would want to cover.

Recent improvements in the housing market, such as the increase in home prices reported by the Case Shiller index and improved sales of existing homes reported by NAR, may have caused a panic among those who are short shares of the most affected players. The ABX-HE indexes are up for the past several days, but nothing too exciting. I regarded the information as favorable for the mono-lines, since it may spell an eventual end to the hemorrhage on structured finance involving sub-prime RMBS, HELOCs, CES etc. However, it still looks like the bleeding will go on for at least another 6 months.

I still think the moon has something to do with it.

Decisions

My only remaining involvement with the companies affected is an options position in MBIA, covered calls I sold at the September 6 strike in order to fund four times as many September 7 calls: long 2,000 MBI, short 20 MBI Sep09 6 calls, long 80 MBI Sep09 7 calls. I have a quick profit; the decision is whether to take the money and run or to hang in and hope for further upside.

Readers know that I have been keeping an eye on MBI's non-GAAP adjusted book value, currently standing at 40.01 with the shares at 6.87 in after hours. The thinking is, the potential upside -- if MBI's management is correct on loss reserves and able to prevail on pending litigation- is very large and not reflected in options pricing. Hence, the attraction of a low-cost position that responds well to a large upward movement.

So, this is about being covered for the big one. I will hang onto the September 7 calls unless or until the stock makes a huge upward move. On the covered calls, if the time value on the calls gets low enough, heading toward expiration, I will plan to lock in my profit on that part of the position.

Disclosure – net long MBI as described in the article, no position in the other companies mentioned.

Comments

[Roger Knights:]

Thanks for the interesting slant on what's happening.

Aug 27 09:45 PM

[John Lounsbury:]

Tom - - -

One thing you didn't discuss is the relationship of the "dash to trash" to the state of the overall market. This type of speculative excess often occurs at major tops. There are more and more people with good track records calling for a correction or a major sell-off. Three people I follow in that camp are Doug Kass, Richard Arms and Ron Insana. This week advance/decline lines have weakened noticably. Candlestick charts are loaded with dojis.

I like your reference to a full moon event, but I think I am going to get ready for Dow 8000 +/-.

Aug 28 11:07 AM

[Oh come on now:]

In the OP, "Recent improvements in the housing market, such as the increase in home prices reported by the Case Shiller index and improved sales of existing homes reported by NAR, may have caused a panic among those who are short shares of the most affected players."

I doubt that seriously. I do not think people see it for what it looks to be to you. I see these reports you referenced as inevitable blips on the screen, certainly not improvements.

I see absolutely no improvement in the housing market. I see a disaster #2 waiting to happen in the housing market. I see the big mess starting to happen in the commercial real estate market.

Aug 28 02:24 PM

[alajac:]

Hope you sold the open, Tom (though by option exp I think we'll be higher). I think we are (next) going to work down for a retest of some moving averages and then get one last big rally starting September option expirations week, pretty much just like in 1938. That should pretty much be "it" for the major upside for the next few years.

Aug 28 03:02 PM

[Tom Armistead:]

What I did was sell enought of the September 7 calls to cover the cost of establishing that part of the position, 14 calls I sold out of 80 I owned. So I got to play the game next month on house money, try to trade my way to owning some free lottery tickets.


On Aug 28 03:02 PM alajac wrote:

> Hope you sold the open, Tom (though by option exp I think we'll be
> higher). I think we are (next) going to work down for a retest of
> some moving averages and then get one last big rally starting September
> option expirations week, pretty much just like in 1938. That should
> pretty much be "it" for the major upside for the next few years.

Aug 28 03:30 PM

[jimmy46:]

Hello Tom
Here's something in the news yesterday:

""Investors who believe that major credit-rating firms should be held responsible for their disastrously optimistic ratings of subprime-mortgage bonds have won at least an interim victory.

U.S. District Judge in New York ruled late Wednesday that Moody’s Investors Service and Standard & Poor’s can’t invoke the 1st Amendment to hide from subprime-related legal challenges.""


Is this ruling likely to have significant benefit for MBA,
or do the rating agencies have 10 more lines of defense?

Sep 04 03:32 PM

[Tom Armistead:]

jimmy,

I was wondering about that myself. MBIA has stated that it is corporate policy to sue anyone whose fraudulent actions have harmed their shareholders. They have not sued any rating agency, although they have been pretty thorough about suing the other parties responsible.

As far as I can see the players in the securitization game seem to have this belief that the normal rules about fraud and so on, even when supported by contractual clauses, just do not apply to their situation. It's like the whole area is supposed to be outside of the reach of established business and contract law.

I found that also going over the financial statements of some of the players, they were aware of warranties and representatons liability and would mention it in passing but setting up meaningful reserves and publishing them just doesn't seem to happen. The belief seems to be that it will just go away if they ignore it long enough.

Jay Brown said it could take 4 years for all of this to be resolved.

On another topic, MBIA made a list of the 20 most concentrated hedge fund holdings, a list that has outperformed the S&P by 14% a year since 2001, the article was here on S-A.

On Sep 04 03:32 PM jimmy46 wrote:

> Hello Tom
> Here's something in the news yesterday:
>
> ""Investors who believe that major credit-rating firms should be
> held responsible for their disastrously optimistic ratings of subprime-mortgage
> bonds have won at least an interim victory.
>
> U.S. District Judge in New York ruled late Wednesday that Moody’s
> Investors Service and Standard & Poor’s can’t invoke the 1st
> Amendment to hide from subprime-related legal challenges.""
>
>
> Is this ruling likely to have significant benefit for MBA,
> or do the rating agencies have 10 more lines of defense?

Sep 04 06:54 PM

[jimmy46:]

Thanks for the answer,
"Jay Brown said it could take 4 years for all of this to be resolved. "

That may be optimistic, I bought some MIR eight years ago,
my account still has some "MIRA##" with a zero value
that represents the litigation value of the suit MIR has against
its former parent.
No end it sight, and that's peanuts compared to the subprime mess.
Your articles are very good, keep them coming.

Sep 05 02:48 PM