Options Trader: Monday Morning Ideas

by: Philip Davis

I’m very surprised by the pre-market. It’s way up at the moment (6 am) but I have a sneaking suspicion that the exuberance experienced by stocks rejoicing by oil being down to $59ish.

The 10-year is crossing my screen at an unbelievable 4.58%; I don’t even know when the last time we say that was! You would think no one is borrowing money... Oh yeah, that is it! This is not as complicated as the talking heads would have you believe: Commodities (including houses) are being converted into cash, which floods the market with dollars. All those dollars like to be lent to someone, but nobody wants to buy a new house at these prices. Corporations are sitting on record amounts of cash and don’t need to borrow and traders are not so hot on the market and are certainly not running up margin accounts.

So, lots of money around, nobody wants it -– rates get low. Wow, who’d a thunk it? Why no inflation then? Because those fat corporations are not extravagant spenders and they sure aren’t giving the money to their employees (other than upper management who are swimming in options) so the average consumer is forced to be a spendthrift. That combined with declining (finally) energy prices gives us a very rare case of an inverted yield curve in a strong corporate environment.

Will this money slosh its way into the market? That’s my bull premise, as you may not have a lot of money to invest, as the top 1% of wage earners in this country are scraping by with $600,000 a year and a mattress is only so big... Without 3rd and 4th homes to buy, what are they going to do with the money? Even the Forbes 400 List has kicked out the last non-Billionaire (sorry Martha), and I hear American Express is coming out with a new card for these people that carries the actual DNA of a politician so the elite can always have one right in their pocket!

That’s why I’m generally optimistic on the markets (even though the socio-economic situation is deplorable), with my only concern being a meltdown in the brokerage sector. The Wall Street Journal agrees with me, and it only took them two weeks to catch up (I must be getting more conservative as I used to be months ahead). So, if the wealthy lose their holdings, the markets are in for a very rough ride. But if the brokers have managed to weather the storm of declining commodities, I don’t see where else all the money can go.

My fear of brokers is neatly summed up by this guy, who’s a little out there but makes a lot of interesting points if you have an hour to kill... It’s a good, but negatively biased, primer on how the markets work.

Asia was fairly flat today while Europe is trading higher as they watch the U.S. futures market fly in the early trading. There was little news over the weekend to move stocks, but nothing blew up so everyone is pretty happy today.

This is a great headline from CNBC: “Thai coup leaders have trouble finding a new Prime Minister.” Job candidate: "So what happened to you last PM?" Coup Leaders: "You don’t want to know..."

It’s a wild and wacky last week of the quarter and I look forward to being in cash by the end of the week. We have been trying to get to cash for a month now but the market just keeps pulling us back in and we only had good reasons to close a little more than half of our successful plays. The open positive positions should have stops that prevent them from either going negative or losing more than 25% of their profits to date.

I hope I’m just being paranoid but take advantage of a good open today to raise your stops.

  • The Dow looked very unhappy affair with 11,600 last week and we need to take 11,650 before I want to get too excited about a rally. Falling below 11,500 is a great reason to take a few more of our open positions of the table. Not breaking 11,600 is not good at all!

  • The S&P chart was virtually identical as the index took a look at 1,325 and retreated back to the safety of 1,315, which it must hold for me to remain bullish. 1,310 is a real problem and a major cash-out level for calls.
  • The NYSE is actually behaving just right as it consolidates properly for a test of the rising 50 DMA. The trick will be for the S&P to stay above 8,300 long enough to pull the 50 DMA over that level. If that happens, I think there is a very high probability of a breakout over 8,500 but this may take a week to 10 days to play out.

  • The Nasdaq is sitting right on the 200 DMA at 2,225 and there’s really nothing else to watch. Without leadership from this index we will have little to look forward to and I would actually prefer consolidation here to a sharp run-up for long-term health reasons.

  • The SOX don’t look so hot, with a big test coming up for them at just under 480. Breaking through this will be nicely bullish but not healthy as it will create a short-term overbought situation. The transports are another excellent bottom indicator as they are resting on a declining 50 DMA at 2,429 and it’s either up or down from here (how’s that for predicting savvy?).

Oil -- ROFL... Oil -- LOL... Oil (oops, fell off my chair)... Oil (ok, just chuckling now -– I think I can get through this)... Oil is down a bit. (Nope, losing it again!...) in European trading, falling below the $60 mark as OPEC not only isn’t cutting production, but global production is now projected to increase by 1.5mbd to make up for the money oil producing nations are losing as the price comes down. That will raise global production to 88mbd against current demand of 85mbd, but they (the oil guys) project that demand will rise to 86.2mbd so they will "only" be producing 2mbd more than people want.

Sorry, I’m back –- had to go laugh again...

OK, so at the end of 2007 year there will be another 730m barrels of oil that have been taken out of the ground and not consumed. I suppose as long as the global economy remains strong and no one makes any great discoveries or any of the record number of rigs now in use don’t produce too much new oil then we might be able to store it somewhere. I can hold a few barrels in my garage if I have to... More on oil below.

Sorry, was out laughing again... Poor housing numbers may save oil from $58 as the dollar should pull back a bit. This will also help gold out as it makes another run at $600 but I doubt it as once wholesale buying season peters out, the physical demand for gold may fall off the table. Today is also the last day of the CBs annual restriction on selling their gold and the quotas reset tomorrow so I wouldn’t touch this sector on the long side with a ten-foot pole!

We still have our Barrick Gold Corp. (NYSE:ABX) $32.50 puts, now $3.90 (up 388%), from way back on the 6th and I'm sorry I never rolled them but let's give it some slack with a stop at $3.30 as a run up to $30 wouldn't phase me in the least but why give up the premium? The Nov $27.50s can be taken for .70 or less as a roll with a stop at .30 letting you take the huge profits off the table with no worries.

Like I said, great day to raise stops and take a little off the table as we try to gauge the games that the funds will be playing this week as they jockey for portfolio positions so they can tell you how great they are doing. I hope they are doing great, my Morgan Stanley (NYSE:MS) and Goldman Sachs Group Inc. (NYSE:GS) puts are a hedge against my generally positive positions because, if they are in trouble – we all are!


We did extensive reviews of closed positions and losing positions over the weekend and I will try to catch up on our open positions in the next couple of days but, again, raise stops, don’t lose money -– it’s a philosophy we can all live with!

  • More bad news for eBay Inc. (NASDAQ:EBAY) as Google Inc. (NASDAQ:GOOG) starts listing some sort of new listing service for items. I can offer this service too but let’s now go backwards on my take on eBay and I will tell you that Google has nowhere near enough infrastructure in place to mount a credible challenge to eBay at this point.
  • I’m hoping General Motors Corp. (NYSE:GM) has a little rally this week ahead of a get together with Nissan in Paris, as I firmly believe there is nothing that can save this company and I will be looking to go very negative on them near $33. Risk/reward on puts at the current price $30.62 is not worth it.
  • I maintain my standing call to buy SIRI at $3.68 or less. But I’m going to as this huge story turned out to be the worst sort of misinformation last week and the guy who planted the story actually got fired for picking on the wrong guy. Hint to manipulators, if you are going to circulate rumors, try not to piss off a guy who has millions of listeners! The stock held up so well against this story that I’m going to take a few Jan ’09 $5s for $1. You can sell the Jan ’08 $5s against them for .70 for an interesting calendar spread but I’m in this for the long haul.
  • All of our oil puts from the Mid-September Update are still in play as they outperformed (under performed?) the rest of the sector and traded down nicely last week (which is why we selected them!). We still follow the Valero Rule to the letter, and let’s keep a close eye on Suncor Energy Inc. (NYSE:SU) and Peabody Energy Corp. (BTU) for signs of genuine long-term enthusiasm (though I can’t imagine from who). If mighty ExxonMobil Corp. (NYSE:XOM) and Chevron Corp. (NYSE:CVX) start to fall, it will be look out below as a ton of longs piled into the sector last week.
  • We have an open spread on Schlumberger Ltd. (NYSE:SLB) with the Nov $55 put at $2.35 (up 4%) that I still really like, and the Nov $60 call at $2.35 (up 9 %) that should be taken off the table if oil can’t get back over $60 on what should be fanatical pumping by US traders.
  • Royal Dutch Shell (NYSE:RDS.A) Oct $65 puts have gone nowhere at $1.20 in 10 days!
  • Cheniere Energy Inc. (NYSEMKT:LNG) was discussed over the weekend as having very big problems if natural gas fails to recover. The Jan $30 puts are still just $3.20 (up 8%).
  • General Electric Co. (NYSE:GE) Oct $35s are just .35 and I have a .20 stop but, if it’s a real rally, they will let us know!
  • Dow Chemical Company (NYSE:DOW) still baffles me with the Dec $40s still just $1 (up 33%) as I expected much more.
  • We need to roll the very profitable Valero Energy Corp. (NYSE:VLO) $50 puts at $3 (up 173%) into the Nov $45 puts for $1.55 with a stop at $1 to protect a 100% profit. The way oil looks this morning; sell the puts on the initial drop and wait for a pullback to hopefully pick up the new calls closer to $1.25.
  • Our Boeing Company (NYSE:BA) Nov $80s are flying high at $1.95 (up 95%) and I am moving this to a .25 trailing stop and looking to add more brackets if there is a real pullback.
  • I maintain my $166 short position on Goldman Sachs Group Inc. (GS) (now $167.50), but I did sell Nov $160 puts for $3.50 (now $3.10) against them (as they continue to make statements like this: ”Goldman cautioned that the market's weakness may be fleeting, as a severe winter could erode comfortable inventories while delays to new oil fields and refineries may put renewed strain on global capacity by the end of this year or in 2007” which indicates to me they are on the wrong side of an oil drop (but maybe they’re just lying when they talk to the press).
  • At this point if those puts go up any higher I will buy out the put holder around $1.75 and take them for myself.
  • On GS (and not wanting to beat topic to death): Q1 was a 54% beat, total surprise coming off an in-line Q4. This past quarter was great but not as good an nobody expects next year to beat this one.
  • MS and GS have outperformed OIH by 40% since mid July on the prevalent myth that they caught the turn in the market on the button.

Oddly there is much evidence to the contrary.

"The size of the positions that Amaranth was letting Hunter take was no secret. It was disclosed to investors, such as major investment banks that included stakes in Amaranth as part of their "funds of hedge funds." Typically, the investment banks market their expertise in choosing the best hedge funds. Yet Morgan Stanley, for example, invested $126 million, or about 5 percent, of its $2.3 billion fund of hedge funds in Amaranth. Without naming Amaranth, Goldman Sachs Dynamic Opportunities Ltd., another fund of hedge funds, said yesterday that "significant" losses on an energy-related investment would shave as much as 3 percentage points off its return this month."

See most people will read this and zone in on the 3% loss - I read the fact that GS and MS knew what the trades were (wouldn't you?) and "blessed" them.

With such a huge stake in Amaranth, do we really believe they were using the fund to hedge their own brilliant short positions on oil and gas?

And then there are margin and market share worries.

This guy mostly agrees with me and he's in the latest Forbes.

XOIL - where's the volume blow-off?

5% Rule on oil:

Throw out series high of $79.86 and use 3 day top of $77.70 on 8/10

5% #1 $73.80 - 50 dma that held as a top for a week Mid Aug

5% #2 $70.12 - consolidation point # 2 last week of Aug

5% #3 $66.61 - danced around 9/8, 11, 12

5% #4 $63.28 - blown through

5% #5 $60.12 - here we are

What do we do when our stock/commodity comes to a stop at 5% without bouncing?

2.5% retracement = $61.69 - might make the new top if it tries to come back but the next 5% down is $57.14 and it could go there before there is a real turn (if at all).