Options Trader: Tuesday Morning Ideas

by: Philip Davis

It’s pass or fail today, kids!

I’ll get into our critical levels later but the big test is an economic one - how much fallout is there going to be from HBS, New Century Financial Corporation (NEW) and now Accredited Home Lenders Holding Co. (LEND), who just announced they need more capital and fewer people. The company said Tuesday it is in talks with its banks about obtaining waivers. "There can be no assurance that the company will be successful in receiving any of the required waivers," Accredited said.

As of Sept. 30, the lender had about $6.78 billion in short-term borrowings, including $660 million from Goldman and $650 million from Morgan Stanley (NYSE:MS). A $650 million line of credit with Merrill Lynch (MER) was supposed to expire last month, and another $200 million credit line from the investment bank is due to expire in June. In addition, it had a $600 million financing agreement with Credit Suisse Group Inc. (NYSE:CS), which was supposed to expire in December, and a $300 million pact with a unit of GMAC Financial Services.

Could this be spreading? The Metropolitan Savings Bank of Pittsburgh won the lottery as it became the first savings bank to fail in American since June, 2004. The bank had run earnings on assets to 1.8% in 2004 by doubling its loan portfolio and ended up squeezed out of existence by diminishing credit spreads. Metropolitan had NO sub-prime mortgages on the books - this was a purely residential issue!

Here’s a few more banks that TheStreet.com feels may be in trouble (remember that FDIC insurance limit is $100,000 - for as long as it lasts…):

Click to Enlarge

Small Banks Under Pressure

Does this just not matter? Maybe not here.

Over in Asia the Nikkei sold off 113 points and the Hang Seng dropped 109 points but the
BSE managed a 77-point gain despite the indictment of three hackers who "used stolen user names and passwords to hack into the accounts and manipulate trading in stocks, including that of Sun Microsystems Inc. (NASDAQ:SUNW), and options on Google Inc."

Europe is trading down a bit and waiting for direction from the U.S. markets. We were discussing Moody's Corporation (NYSE:MCO)’s strange decline yesterday in comments and decided it was due to a tussle they are having in Europe over suspending the rollout of revised bank ratings "in order to refine the methodology behind it." Looking at the above chart - don’t you think a little refining might just be the prudent thing to do?

Today we have the retail sales reports to look forward to and you can bet gasoline sales are way up as prices skyrocketed during February, thanks to a "fire sale" at Valero Energy (NYSE:VLO) and Tesoro Corporation (NYSE:TSO) refineries. Tomorrow we have crude inventories, but Thursday we get the Citigroup Funding Zero Cpn Nts (PPI), which has a ridiculously low expectation of .2% and the ever-depressing Philly Fed Index followed by Friday’s CPI, which should also be boosted by gasoline prices.

It’s all about Goldman Sach's (NYSE:GS) earnings this morning and you know my concerns there, I did an extensive review of their prospects in Friday’s comments and I’ve sold the $200 calls short so that’s full disclosure on that one!

I predicted yesterday that we’d be watching our danger zones today and the pre-market (7:35) seems to agree with me but a lot can happen in the next two hours, so here’s both sides on the chart:

US Markets

US Markets

So not looking so bad on the whole, but with worrying pullbacks from the Transports and the Hang Seng. As I’ve said befrore, if the transports can’t rally off sub-$60 oil, we have a problem! Let’s not forget that 38.2% is supposed to be the FIRST stop on the road to market recovery. A pullback here CONFIRMS THE DOWNTREND…

Energy traders will be gnawing their own legs off today to avoid confirming a downtrend in oil prices. I’m still waiting for the stocks to drop but I’m generally pleased with my Friday morning strategy where I said: "I could be totally wrong here, especially with a strong jobs report indicating a resurgence in the U.S. economy, but I’m going to put it on the line and short oil into the weekend so I’m just praying for them to rally that sector today so we can jump in and SELLSELLSELL."

The long-term chart of the April crude contract shows us running quickly out of bounce time as it closes next Tuesday, pretty far down from its $75 high in June, just a bit below the Jan ‘06 opening bids at $61. I’ll update the barrel count in tonight’s post. Both oil and gold should get some relief as bank failures tend to erode interest in the dollar ever so slightly. As has been typical lately, any attempt by the dollar to rally has resulted in spiking sales volumes, which drive it back down courtesy of our friends at OPEC and Russia, who prefer to sell their commodities in a weak-dollar environment.

If oil can’t retake $60 today, they may be in deep trouble as Zman predicts more downward pressure ahead for oil and gas as the weather finally heats up and "refining industry snafus sort themselves out." We have the OPEC meeting in Vienna on Thursday, usually a 2 day affair so the weekend is bound to be tricky - stay tuned!

Oil and Dollar


We’re going to lock an load a couple of mattress plays today but the time to make these plays was really last week, when I called for them and the tricky part was holding onto them yesterday as the markets moved against us but, as I said in comments yesterday when asked if I thought we should remove DIA puts: "DIA puts were there to protect STP and LTP rather than sell off positions and we’re up 4% on the STP and flat on LTP (because we sold calls). That’s why it’s insurance, like life insurance, you need it but you kind of hope you’re wasting your money…"

Those insurance plays allowed us not to panic out of our calls and get the most out of this 33%, 250-point bounce we’ve had in the past five sessions, when I suggested taking the covers rather than selling which did, in fact, turn out to be a perfect bottom call. I also called for 15% trailing stops on all call contracts and they should be triggering like crazy this morning and I will be exercising mine if just on of our 4 green indexes (above chart) turns red.

A few of plays I like are:

• iShares Goldman Sachs Semiconductor (IGW) Apr $60 puts (IGWPL) for $1.75
• iShares Russell 2000 Index (NYSEARCA:IWM) May $77 puts (IOWQY) for $2.05
• Diamonds Trust, Series 1 (NYSEARCA:DIA) Apr $122 puts (DAWPR) for $1.45


8:30 Update:

Goldman Sachs Group (GS) had massive numbers with a 29% jump in profits, much more than expected. EPS was an amazing $6.67 a share vs. $4.97 expected and they claim that subprime is a manageable problem for the firm and they maintain that "the broader credit market remains strong." This is the spin we expected from them, now we’ll see if traders are buying it this morning.

Retail sales came in weak at .1% vs .3% expected and that will have more bearing on the markets than GS earnings.

CNBC is spinning this IEA report to mean we are in some kind of Global Energy Crisis due to this SHOCKING drop in supply:

World Oil Supply

SHOCKING, isn’t it? Almost half as devastating as the SHOCKING supply drop in Q1 ‘05 and close to 1/4 of the SHOCKING supply drop in Q1 ‘04. Will the world survive? CNBC says only if you pony up $4 per gallon to save the poor oil companies who are burning refineries as fast as they can for your viewing pleasure…

Let’s be careful out there today!