Options Expiration Day Promises a Wild Ride

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 |  Includes: BAC, C, FAS, FXI, INTC, JPM, SMH, SPY, XOM
by: Philip Davis

As Jesse notes over at Cafe Americain, it’s shenanigans central today.

We are mostly watching the action with a detached interest. As I said to Members in yesterday’s morning Alert: "Tomorrow we have CPI, Business Inventories, Industrial Production, Empire Manufacturing (which was awful last month) and Michigan Sentiment and then the 3-day weekend so cash will be comforting until Tuesday at least!" Yesterday was an excellent day to take the money and run on our bullish positions - even though we did finally make our levels, my final word in that Alert was: "Be very careful today, I still feel like this whole thing can snap on one bad news story."

We did take earnings spreads on JPMorgan (NYSE:JPM) and Intel (NASDAQ:INTC), both of which seem right on target at 7:30 (see this morning’s Alert for adjustments) with INTC giving us the strong numbers we expected and JPM doing well, but not well enough to live up to the hype.

Earnings season is like party time for options traders, especially on expiration week where we can take advantage of low premiums on the things we buy while still selling high, earnings-inflated premiums on the things we want to sell. The INTC trade was taking the Feb $22/23 bull call spread for .27 (a cheap way to make $1) and reducing our basis by selling 1/2 that number of Jan $22.50 calls for .12 (a ridiculous price for a call that was $1.20 out of the money when we made the trade in the morning but we only sold half, just in case!) and also selling the Feb $19 puts for .17. Those we sold the full amount of as we REALLY don’t mind having Intel put to us at net $19.04 as .17 and 1/2 of .12 = .23 off our net .27 purchase of the bull spread, so we’re in for a grand net total of .04 with the upside potential of making $1 if INTC makes it to $23 by Feb expirations. Even if we only cash out our Feb spread for .12 (less than half of what we bought it for), that’s still a 200% profit on the net spread! This is why we LOVE earnings season!

Option Hedging StrategiesOur Trade Idea for JPM was in that same 10:47 post and in that one I said to Members: "JPM - Great Expectations so I like the $44 puts for .55, selling the Feb $41 puts for .52 on the premise that I make $3 fast on the way down to their level (so rollable) and, if it goes up, I never have to pay them. Consider that $1.50 of downside protection on the spread so the Feb $43/45 bull call spread for $1.10 seems like a good deal as a pair trade." So our goal is mainly to take the bullish spread, but we’re hedging for short-term disappointment, just in case, with the put spread that works out to free (net .03) protection if JPM does not disappoint. As this one stands, we’ll be cashing out the January puts into an early sell-off and letting the rest ride as we are happy enough with the .74 profits (.60 expected) to ignore the 6% revenue miss.

We took much longer-term bullish plays on Citi (NYSE:C), BofA (NYSE:BAC), JPM, and FAS yesterday but all hedged as we certainly don’t believe we’re heading up in a straight line. Shorter-term, we took advantage of expiration day with plays that are likely to make 100% in 24 hours like selling FXI $42 puts for .27, selling SMH $27.50 puts for .20 (another bullish play on INTC). Trades like that pick up $270 here and $200 there and, before you know it, you are talking some real money! 1,150 is our next critical test on the S&P and we briefly touched it yesterday. As you can see from Jesse’s chart, we are forming weaker and weaker tops to our pyramid of nonsense, which means our foundations are very poorly constructed and the whole thing could collapse - but when? (Click chart to enlarge.)

Is this similar to early 2004 (our current theory) where we ramped 50% off the bottom of the S&P and then trended down for the year but eventually went on to form a real bull market, or are we in another bubble top, repeating all the same mistakes of 2007 and about to suffer the same consequences?

It would be wrong of me to say we are repeating the same mistakes we made in the past. We are, in fact, making much bigger mistakes and doing so at an even more frenzied pace. There is no real doubt that the major financial institutions, through market manipulation and derivative trading, fulfilled Warren Buffett’s 2003 prophecy and became "financial weapons of mass destruction."

So what have we done to "fix" our problems - clearly we have handed the inmates the keys to the asylum, giving the SAME idiots who wrecked the economy the first time $700Bn in bailout money and, just yesterday, the Fed announced that they have given them an additional $1,137,000,000,000 since last January after giving them anoher $14Bn just yesterday in exchange for their possible worthless MBS paper. That’s right, the Fed gave GS and company $1.1Tn in cash to play with in exchange for $1.1Tn worth of mortgages they were stuck with AT FACE VALUE. No wonder these guys are making record profits and taking record bonuses - they were given $2Bn in taxpayer money to play with. As I mentioned yesterday, they repaid our kindness by doubling the price of commodities in 2009, costing US taxpayers alone over $400Bn and costing global consumers over $2Tn of their "disposable" income.

Isn’t that great?!? We’re going to make a fortune on our bank bets, and Exxon (NYSE:XOM) (Monday’s pick) is holding up nicely, and it looks like 2010 is going to be a great time to be a bull as I think we can squeeze another $2Tn out of the bottom 90% and the best part of it is - THEY AREN’T EVEN SMART ENOUGH TO GET UPSET! That’s right, I can write these articles and call them sheep and tell them the oil companies are ripping them off and even give them a link to write to Congress (who were paid $114M to take those letters and drop them right in the shredder) but it changes NOTHING! As Samuel Jackson said in Pulp Fiction - I do try very hard to be the good shepherd but the flock seems to be hopelessly lost and lamb stew sounds pretty good right now.

As other "good shepherds" have learned in the past, there is no profit in preaching to the masses, and you don’t have to nail me to a cross for me to get the message that it’s time to give up on reform and join in with the wolves to devour the flock. Speaking of crosses - there was a little crossed signal on someboday’s trade-bot Wedneday as an HFT program misfired at 11:03, as the same "market particpant" bought and sold 200,000 shares to themselves in 2 minutes. Of course, this is the kind of BS that goes on every day - only Rule #1 of market manipulation is, "Don’t be so friggin’ obvious!"

Karl Denninger does a good job of sussing out the details of how the market breakout we had on Wednesday was prompted by the action of a single buyer, who placed a MASSIVE buy order on the S&P while SIMULTANEOUSLY selling himself all the shares as well, which created the impression of a surge of buying interest at "the bottom" and dragged a fresh round of suckers retail traders suckers into the market for another round of "bottom fishing" at the 52-week highs.

Karl suggests we follow the money to find out who has $562.5M to trade on each side of this trade but, sadly, Karl, the answer is: dozens of people - more like SCORES of people - and that’s why we are giving up and dining with the wolves because the sheeple really are just that, and they will keep chewing grass and getting fleeced until the next time they look fat enough for the slaughter - and that’s when Da Boyz will flip short and whack their pension funds for another 50% loss while the government comes running with bags and bags of money to make sure the wolves weren’t injured during all their feasting. Happy 2010 - meet the new boss, same as the old boss and you WILL, apparently, get fooled again.

Asia was full of mixed signals this morning with the Nikkei continuing its run (up 0.68%) and the Hang Seng continuing its decline (down .28%). But the Shanghai had an up day (up .27) and the BSE was down (.17) with the Tech sector generally leading both on INTC news as well as an NPD report showing record video-game sales of $5.53Bn last month (and I will remind Members that we have several game plays on our Buy List!) led by a 77% increase in Wii consoles (3.8M) and an 87% jump in Sony's (NYSE:SNE) PS3 (1.36M) while Microsoft (NASDAQ:MSFT), of course, manages to screw up and drops XBox sales 9% to 1.3M units, once again spurring calls to replace Steve Ballmer with a Magic 8 Ball or perhaps a gecko (it doesn’t even have to be the smart one on TV, putting any small lizard in charge of MSFT would be much less harmful to shareholders).

Rumors that Angela Merkel is actually a giant lizard or will be quitting her post as Chancellor were denied this morning as "absurd" but that didn’t stop dollar manipulators from getting a lovely half-point pop against the Euro, putting them into early consideration for the most money made on the stupidest rumor of 2010. The obvious move here is to now go long on the Euro at $1.435 to get back to $1.445 on the bounce, but I never play the currency markets for precisely that reason.

So hopefully next week we can get back to pretending that fundamentals matter as we get earnings reports from over 200 companies in just 4 days (Monday we are closed). We are playing some speculative bearish bets over the weekend as this house of cards can collapse at any moment but our hearts are no longer in it as it is clearly going to be more rewarding to run with the wolf pack - at least as long as it lasts…

Have a good weekend,

- Phil