A Long/Short Play on Monoline Insurers

On November 5th we singled out mono-line insurers ABK ($30.42) and MBIA ($39.81) as two of the financial stocks most likely to have bottomed and on the verge of being beneficiaries of a massive short covering rally in the financial sector.

Though we have come a long way in price in many names from the lows, the rally will probably still carry further and there are ways to profit even from here, at, albeit, reduced risk through short hedges.

One idea that seems unusually compelling is to take long positions in conjunction with short hedges in stocks that have rallied to much more obvious resistance levels. For example, ABK has broken through various resistance levels quite easily, and is up more than 50% off the lows (intra-day lows 11/05 to intra-day highs 11/14). But based on what peer mono-line AGO ($21.88) has accomplished even quicker (closer to 80% off the lows), we believe a reasonable low-risk high opportunity long/short arbitrage is perfect for this market.

We'll toss out the fundamentals for the time being, given that few analysts except those at Pershing Capital nailed this disaster in the mono-lines in time (May 2007); Congrats to them. But both companies are essentially in the same business. And charts have remarkable similarities - one has retraced a steep drop (AGO - moved up back to major resistance), the other (ABK) is in the process of doing so (next stop in major retracement looks like 40).

If it doesn't retrace all the way up to close to $40, or if we get material pullback in the mono-lines, you will still get more upside in ABK than AGO, and less downside as well.