Options Trader: Thursday Outlook

Includes: DIA, QQQ, SPY
by: Philip Davis

We have a lot to think about today as we need to decide what to do about these crazy markets.

We’ve seen some brief signs of strength but the dollar continues to fall and gold and oil continue to rise and something has to give at some point but that point may not be for another month - it’s almost impossible to call. The problem is that we can’t get a clear picture of what’s really happening in our multi-Trillion dollar housing crisis. Bloomberg writes an article about "Ghost Towns" of empty homes that point to a massive crisis on the same day that Marketwatch tells us "The Foreclosure "Crisis" is Overblown."

My current view on this is that, while we may indeed have an actual crisis on our hands, it is mainly priced into the market at this point although I thought the same about all the fear and terror being priced into oil and I’ve been dead wrong about that (of course it’s the death of the dollar that really pushed us over the edge). What’s not priced into the market is a bomb that blew up in Times Sqare at 3:45 this morning.

Whatever actually happened in NY, this can send a very strong signal overseas that our market confidence is strong if we manage to scratch out a decent day today. Much like I observed in Pakistan last week, an EU analyst will say "Wow, a bomb blew up in Times Square and the US markets shook it right off."

Another thing we need to shake off today is Carlyle Capital and I will look to buy some financials if they sell off on the news that Carlyle failed to meet margin calls on its $21.7Bn portfolio yesterday. How can I say this? Because THIS is what I said about this issue way back on August 28th:

Also in denial is the Carlyle Group, who have agreed to "lend" ANOTHER $100M to Carlyle Capital Corp, "a highly-leveraged fund that has been forced to cancel its dividend and sell assets to meet margin calls less than two months after listing on Euronext Amsterdam." Carlyle Capital already used up the entire $100M they were "lent" LAST WEEK so it will be interesting to see how long this round lasts them. I love the word "lend" because it carries with it the assumption of repayment! Carlyle Capital floated on Euronext Amsterdam in July with about $880 million. By using borrowed money, it leveraged a portfolio of U.S. residential mortgage-backed securities and other asset-backed securities by 26 times, to $22.7 billion in investment assets.

That means that by losing just 0.4% of their asset value, the company can wipe out 100% of their working capital!

This is how that game is played - the end commodity "values" of homes, oil, metals, stocks… are determined by a series of paper transactions that "create" wealth on balance sheets but that "wealth" (which in Carlyle’s case is leveraged 25 to one) is very difficult to return to investors unless there is another heavily leveraged sucker willing to pay even more in the next round.

I know I should stop being stunned by this nonsense but CNBC just (7:35 am) reported that Carlyle Capital had lost "just" $30M to $40M on the $900M worth of assets it has been forced to sell to meet debt obligations. What about the other $21.8Bn? Did they lose 3.3-.4.4% of that too ($800M+) or was that $900M perhaps the strongest assets they had (since you usually can’t sell the weak ones in an emergency)???

So let’s take this "shocking" news about Carlyle with a grain of salt - they’ve been on life support since the summer. It took me 6 months to be proven right about Carlyle and I’m still waiting for investors to realize that shiny bits of metal and gooey black liquids don’t have any real value either!

(NYSE:WMT) posted great numbers this morning with sales up 2.6% for the month, double what analysts expected. By itself this is not exciting as WMT is where you expect pinched consumers to flee to to stretch a dollar but big screen TVs and consumer electronics in general came in very strong. The retail sector in general has been surprising analysts, who are about as hard to surprise as my new niece is when we play peek-a-boo as neither she nor they have a clue about how the world works and are easily surprised by almost anything that happens.

Speaking of anlaysts, if you read other blogs (and I can’t imagine why) chances are 3 out of 4 of them are bearish as the Blogger Sentiment Index is back near it’s all-time high bearish level at 52.17%. The last time sentiment was this bad was last March, just after we had our Asian led meltdown that took the Dow from 12,795 to 11,939. Turns out we lived through that one too!

Asia lived through the morning and took our close as a sign to stop sliding this morning. The Nikkei rose 2% to 13,215 and the Hang Seng hung on to 23,000, up a point to 23,342. China’s Central Bank attempted to defend the dollar by talking down the Yuan and Japanese business data is running cold again, statistics that (fortunately) deflate the Yen.

Europe is off about half a point ahead of our open and the BOE and ECB left their rates on hold, despite mounting inflation concerns in their effort to support the dollar which, arguably, is causing most of the inflation in the first place. Still a problem over in Europe (and here) is something we pointed out quite some time ago - the cost of insuring debt agains default is up 20 times in the past year - this is a tremendous cost to debt issuers, now at 2% of the debt. This is putting a lot of deals on hold!

There’s a great article in the Journal on the potential deleveraging of $16Tn of US financial sector debt that explains how this can all end in tears: "When lenders demand bigger down payments and higher interest rates from home buyers, for example, that effectively makes houses more expensive. Prices decline until houses become affordable again. The problem is falling prices make lenders more nervous about the collateral backing the mortgages they’re selling and holding. That can cause them to tighten lending standards even further."

"Consider developments last week in the municipal-bond market. A handful of hedge funds had used borrowed money to buy seemingly safe municipal bonds while also wagering that Treasury prices would fall. Both bets went wrong, and lenders started demanding that the hedge funds repay their loans, forcing the funds to sell the municipal bonds into a falling market. That pushed prices for the bonds even lower."

"Wash, rinse, lose your shirt."

Let’s hope we don’t lose our shirts today! We covered and rolled our covers yesterday but we did sell some DIA $123 puts against our longer puts as we hoped we were done going down at 12,200 but it looks like we’ll be testing it again this morning so we’re going to be careful out there for sure.

Congrats to Warren Buffett, who went back to #1 as the richest person in the World with $62Bn. Warren was smart and took my advice, holding onto his own stock when it was "just" 86,000 back in August of 2006. Today, Berkshire’s shares sit at $139,000, not bad for 18 months! Poor Bill gates dropped to third with "just" $58Bn (see what happens when you give money away!) and 179 new Billionaires were created in 2007, bringing the total to 1,125 as the rich got much, much, richer.

At this point, it might be a good idea to say: "Gee I wonder if that Buffet guy knows something about making money." Unlike Gates or Slim, who are both, essentially monopolists, Warren Buffet got rich the way we’re trying to, by picking good stocks! We’ll be looking at these for some entry opportunities as the market starts to recover: (NYSE:AXP) (13%), (BNI) (18%), (NYSE:KO) (9%), (NYSE:JNJ) (3%), (KFT) (9%), (NYSE:MCO) (17%), (NYSE:PG) (3%), (NYSE:USB) (4%), (NYSE:WFC) (9%), (NYSE:WCC) (80%!).

My own by and hold pick for the week is some much needed FUN, an amusement park operator who pay a very nice 8% dividend. I like them because when parents can’t afford the big vacation they take their kids to the local parks so business should be good this year and the stock traded down with the market and took a bounce off the 50 dma so they are a buy and accumulate at $22.25, saving at least half for a possible retest of $19 if the market tanks.