Options Trader: Thursday Morning Ideas

by: Philip Davis

The markets seem once again determined to open positive, so who am I to argue?

In my wrap-up yesterday we discussed a possibly disastrous situation developing in the bond markets, and this morning I see that Morgan Stanley (NYSE:MS) is being fined for overcharging retail investors as much as 18% on bonds they recommended as "safe" investments. MarketWatch has an article about 20 tipping points that can wreck this rally and the WSJ has had to start a chart to track How Credit-Market Tremors Have Affected Junk Bonds, LBOs and Hedge Funds.

Just this week alone they’ve added the following:

07/30/2007 IKB Deutsche Industriebank AG   Profit problems   CEO left; profit warning issued   Company says it can’t maintain its earnings forecast of EUR280 million for the 2007-08 financial year; IKB says it has "felt the impact" of the U.S. subprime crisis; Commerzbank said the difficulties will shave its profits by 80 million euros  
07/30/2007 American Home Mortgage Investment   Margin Calls   Banks demanded more cash after the lender wrote down the value of its loan and security portfolios   Shares of the real-estate investment trust were halted for more than a day; lender delayed paying dividends on common stock, may delay payments on preferred shares because of margin calls; may have to sell assets, find new financing, or restructure debt to meet banks’ demands  
07/30/2007 Stoneridge   Offering delayed   $200 million senior secured term loan postponed indefinitely due to "unfavorable market conditions   The electronic component maker was forced to cancel its tender offer to purchase its $200 million in outstanding senior notes  
07/30/2007 Insight Communications   Offering delayed   Bids for the New York cable operator were due yesterday, now delayed more than a week by the firm’s bankers   Bankers at Morgan Stanley delayed to give private-equity bidders more time to line up financing  
07/30/2007 Commerzbank   Hedge fund losses    German bank said its total exposure to the US subprime market is 1.2 billion euros   Set aside 80 billion euros to cover exposure to US subprime market   
07/31/2007 C-Bass   Margin Calls    MGIC Investment and Radian Group say joint venture C-Bass has been subject to an "unprecedented" amount of margin calls, adversely affecting liquidity    C-Bass said it is in advanced discussions with a number of investors to provide increased liquidity; MGIC said it would write down its $516 million investment in C-Bass, possibly to zero; Radian Group said the same of its $518 million stake   
07/31/2007 Sowood   Hedge fund losses    Boston firm suffered losses of more than 50% this month, dropping the firm’s assets to about $1.5 billion from $3 billion    Sowood said it will wind down its two funds   
07/31/2007 CNA Financial   Profit problems   Chicago commercial insurer reported lower quarterly earnings as investment losses increased due to write-downs on subprime debt   Company says it suffered $91 million in losses, partly due to a $20 million write-down related to subprime debt; this contributed to a 9% decline in quarterly profit  
08/01/2007 Fortress Investments   Hedge fund losses    Macquarie bank’s high-yield Australian fund said investors could face losses of up to 25% due to U.S. market fallout    Fortress has had to sell some assets, said average price of assets in the portfolios had fallen by 4% in June and may have fallen a further 20-25% in July; could face margin calls if assets don’t sell well   

Woo-hoo - party on Garth… I think I’m going to officially move the clock forward and declare us to now be partying like it’s 1999.5! Congrats to all you late-night revelers as we share the last, flat, warm dregs of the keg and have a few stale jello shots before we jump in the car and drive home. Irresponsible? Hell, no - it’s a party and don’t you dare say otherwise!

Today you will hear the MSM (Mainstream Media) tell you that the bond sell-off means people are moving money into stocks, but that is not the case. As we saw yesterday, the bonds are being sold to pay the margin calls on bonds. This old-style thinking comes from the very ancient assumption that the people who hold bonds have money. These days, the Yen carry trade has made it possible to speculate in bonds, so the low interest rate that has been fueled by record bond participation COULD ITSELF BE NOTHING MORE THAN A SPECULATIVE BUBBLE.


This is how the Nikkei finished positive, a 311 point run in the last 90 minutes of trading, a trick they must have picked up from our Dow finish yesterday. The Hang Seng jumped about 300 point the minute they got back from lunch (I’ll have what they’re having!) and the Shanghai also staged a spectacular recovery at the close as well. The BOJ’s ultra-low rates are beginning to form a real estate bubble, driving land rates up 8.6% nationwide but up 13.1% in crowded Tokyo with gains as high as 33.3% in the Ginza shopping district. I wonder how long the BOJ will put up with that?

Strategy For Victory

The Bank of England left their rates at 5.75%, taking a pause after five increases in the past year after earlier inflation troubles in April forced the The Boeing Company (NYSE:BOE) to write a letter of explanation to the Chancellor (Gordon Brown at the time) for missing their target. Unilever’s earnings showed strong EU consumer demand and Credit Suisse Group (NYSE:CS) posted huge numbers, while TOTAL S.A. (NYSE:TOT) was disappointing, in line with our expectations for integrated majors. Nokia Corp. (NYSE:NOK) and NYSE Euronext (NYSE:NYX) also posted strong quarters.

ArcelorMittal (NYSE:MT) were happy to announce that, now that they have their little cartel all organized they will (surprise, surprise) be cutting production AND raising prices - ahh, the joys of rampant, unfettered M&A activity!

We’ll see how our markets hold up today, we are still a long way from getting excited, but as I said in yesterday’s morning post - not in panic mode either.

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US Markets

Let’s watch those "must hold" levels VERY closely, but of course we’re going to bounce off them - that’s why I predicted months ago that those levels MUST HOLD! If the S&P can’t retake 1,470 or Nasdaq and SOX slip out of our DIScomfort zone, you aren’t going to like the direction one bit so feel free to join the lemmings as CNBC et al tells you to BUYBUYBUY. I’ll be sitting on the sidelines for now, though, keeping tabs on where the money flows so we can position for the real action later.


Does that sound familiar? I just pasted it from Monday and, if you look at that day’s chart - you’ll see that we could have just taken this week off so far as NOTHING has changed! What has changed is that Criminal Narrators Boosting Crude (and the Markets) are now trying to tell you that retaking Monday’s pathetic levels constitute some kind of rally but I maintain a Pebbles-level "no bottom fishing" policy until we see some sort of proper breakout.

This week has indeed offered us a REALLY good chance to see how our various holdings perform under pressure and, thanks to our index puts, we were able to hold onto them as they recovered. I am skeptically hopeful or hopefully skeptical, I can’t decide which - but it will be another interesting day to watch (and not play!) the markets!

As I said to members yesterday, our goal is to "strangle" the Dow, keeping tight puts and calls on both sides to protect our balanced (and well tested) portfolio from suffering from a huge move in either direction and, also, to take advantage of a big move with another index win. That means we buy puts on the way up and calls on the way down until we find ourselves overhedged. Then, through rolling, we tighten, tighten, tighten until a 300 point Dow move in either direction gives us a better than 50% gain.

We loaded up on Apple (NASDAQ:AAPL) yesterday and I gave the October $145s at $6.75 to MN1 viewers and listeners yesterday morning. My 11:50 response to Optrader, who was spot on with his own call at 11:35 of: "AAPL - might be worth considering calls if it strongly breaks $132.10," was to say "AAPL - you wimp! I just stuck my neck out on national radio and said Apple Apple Apple - I’m willing to go down in flames on that one…"

It looks like my neck is safe for another day as the Strategy Analytics report says: "We expect Apple will push toward a 1 percent quarterly share by the end of 2007 and is well capable of shipping more than the 10 million units conservatively projected by Apple to be sold in 2008." Provided the iPhone launch in Europe later this year and elsewhere goes according to plan, Strategy Analytics said Apple stood a good chance of becoming the world’s sixth-biggest mobile phone vendor by 2009.

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Oil Gold Dollar

Have a great day!