Options Trader: Friday Morning Ideas

by: Philip Davis

It’s Friday (the 13th!) already?

Darn, and we were having so much fun!

Isn’t this a great job - we hang out all day and follow the markets, make a few bets, make some money and chat amongst friends. I find myself anxious for Monday some weekends so we can get back into it and this is certainly one of those weekends. We have lots of data, earnings and Uncle Ben testifies to Congress, so it’s going to be fun and exciting.

Meanwhile, finishing up this week, General Electric (NYSE:GE) (my favorite company) pulled off in-line earnings on strong sales, despite taking another $200M charge on their sub-prime lending division (they got hit for $500M last Q). Does this mean the sub-prime picture is improving? Sorry, no - it means that GE dumped $3.7B worth of subprime loans on WMC Mortgage and is selling the rest of the division, exiting the US mortgage business.

Working for the Weekend

On the opposite side of the planet, mega-electronic corp Samsung posted a 5% profit drop, generating just 1.42 Trillion in net income (won, that is!), the smallest profit ($1.54B) since the recession of 2000-2001. Chip margins fell from 30% to 8%, down from 12% last quarter and cell-phone margins fell from 13% in Q1 to 7.7% in Q2. The only profitable division for Samsung was LCDs, which jumped to 8.6% from 3% in Q1. Despite the troubles, the stock stayed strong on RUMORS that Carl Icahn has an interest in the company.

Asia isn’t worried about this, so why should we be (because we are rational, that’s why!)? Hong Kong (up 1.2%), South Korea (up 3%), Singapore (up 1%) and India (up 1%) all finished at all-time highs, while Australia pulled back a little from an intraday all-time high. Exporters led a relief rally as fears of a US consumer slowdown were calmed by the performance of the US markets.

Europe is not as exuberant as Asia, but is up across the board and the DAX, which dropped 150 points on Wednesday morning, is now flirting with record highs. Earnings season is off to a good start in Europe and the markets there are all working their way into record territory as well. Interest rates are kicking up in Europe and all over the world as this global stock rally is being fueled by $353B in margin borrowing in the US alone.

Strategy for Victory

Import prices were up 1% in June, vs. .6% expected while retail sales were down .9% vs. down .1% expected. The retail sales less autos (which we knew were pathetic) were down .4% vs. the down .2% expected, so we have once again exceeded very low expectations but this time to the downside! I predicted yesterday in my list of bad news to come,that this number would be a miss and would get much worse in July, as the dollar has plunged 2% and oil has gone up 4.2% since June. Will this finally matter or will the market continue to whistle past the graveyard?

Also as predicted by me, oil prices drove the trade gap to my $60B mark, despite the fact that our volume demand for oil slowed in May. Gasoline sales were off 1.1% last month - no wonder T. Boone and Flynn rushed to the studio this morning!

Zman is buying into my "Blow-Off Top" theory in oil and is looking at a possible key reversal, but, as expected, Nigerians are back to kidnapping people (it’s been almost two days!). This is driving Brent Crude to an 11-month high of $77.45; it has also, however, pushed Brent into backwardation, a situation that can lead to rapid price declines as the front month prices exceed the prices speculators can expect to get in the future, causing them to rush barrels to the market. "Markets move to backwardation when demand is strong," said Dennis Gartman, the editor of The Gartman Letter trading note. "The market is no longer willing to pay for a commodity to be stored and instead is marking prices higher to draw upon available reserves."

We will be focused on our refiner plays and Zman points out that Western Refining, Inc. (NYSE:WNR) and HOC have really gotten ahead of the group in terms of valuation:


With crack spreads in rapid decline, it will only take one earnings miss (VLO leads the group off on 7/31) to send Holly Corporation (HOC) and WNR into a pretty good correction, so we’ll be playing the HOC Aug $75 puts at $2.25 and the WNR Sept $55 puts at $2.12. However, we'll be scaling in slowly ahead of earnings as oil above $73 will continue to support the group. Let’s keep an eye on gasoline, though, which should abate as summer driving season continues to disappoint. We hit the jackpot this morning on Baker Hughes Incorporated (NYSE:BHI) as my members pick from yesterday was:

BHI Aug $85 puts at $1.62 XXX
BHI July $85 pts for .30 as a fun play XXX

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Oil and Dollar

We are hoping for the big breakouts, but please maintain at least a mild degree of skepticism in case someone decides to take away the punch bowl one day.

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US Markets

I’m still enthusiastic, in the "pretend nothing bad matters" sort of way. We have to do it to enjoy this rally and we’ll see how we shake off a bit of disappointing news today. Let’s be careful out there keep our mattress plays tight and try to have some fun!

Have a great weekend,

- Phil