Could Morgan Stanley Go Belly Up?

Oct. 4.11 | About: Morgan Stanley (MS)

By Michael J. Zerinskas

The short answer—Yes. Unfortunately, the long answer is also ‘Yes,' but lets delve in a bit further.

Despite disclosure regulations, no one really knows the extent of the exposure to Greek and other European (potential) defaults. You do not have to be a historian to remember what happen last time a major default happened that did nto have quantifiable risk exposures.

So, could Morgan Stanly (NYSE:MS) be up on the chopping block, like Lehman was only a few years ago? It is certainly possible. Perhaps what is most important, though, (even more important than the actual exposure on MS's books) is the fact that people are starting to believe that it is possible.

Take a look at January 2012 LEAP options… The lowest available strike is the $3.00 put, which is actually bid! Currently at $0.15/0.17, the strike is running at 183% volatility. Overall historical and implied volatilities for Morgan Stanley are trading at 86% and 97%, respectively. This is also up dramatically from only a few months ago, when HV and IV were averaging 22% and 24%, respectively, despite a continuously declining stock price.

OK, that's a lot of jargon; what does it all mean? In layman's term that means that traders, large money managers, speculators, and even individual small lot traders have all of a sudden become very, very worried that Morgan Stanley could visit the $3.00 mark over the next 110 days. And, frankly, if MS is going to $3.00, people might as well be saying that it is going the zero.

Options are not the only tip off here. Credit default swap rates for Morgan Stanley have just hit their widest level since 2008, currently +24 basis points, at 518bps. This should be self-explanatory; bond traders and bondholders are nearly as scared of a default as they were in 2008.

Morgan Stanley's preferred stock (MSPRA) is also trading at its lowest level is at least a year. It has already broken through the August lows, despite the common stock currently holding above it.

One of these occurrences in isolation does not a trend make. However, we do seem to have a stepping-stone of pessimism, so to speak, surrounding anything with the Morgan Stanley nameplate. Tread lightly here and, perhaps, buy some OTM puts as lotto tickets.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.