Who Will Trigger E*Trade's Magic Moment - and a 111.4M Short Squeeze?

If one only hears some pundits talk about E*Trade (ETFC) or looks to analyst opinions for investment guidance, one wouldn't know that E*Trade is this year's best brokerage stock, one of the very few financial stocks with a positive return, and one of the S&P 500 stocks that has double digit gains. Technically speaking, it also has another bullish component to support its positive price actions since January--volumes. E*Trade’s pattern of daily volume is high on rising days and low on consolidation days-–a classic bullish sign.

To close watchers, E*Trade, as a company, has definitely, albeit not widely reported, been on a strong cause of turnaround:

1. The home loan portfolio, well the loan portfolio that remains since E*Trade sold off the most risky CDO portfolio in November 2007, has shown first signs of improvement as reflected in declining trend in new delinquent loans (as discussed in both the April Q1 Earnings Conference and again in the May Annual Shareholder Meeting);
2. E*Trade’s overall cash position with its year end target of accumulating $1 billion excess cash will likely be achieved by this July 2008 quarter (see details in "Seeking E*Trade’s ‘Magic Moment"
3. E*Trade’s risk capital ratio is among the highest nationwide, a close second to JPMorgan (JPM).

Just the other day, James Altucher from thestreet.com acknowledged the bullish trends affecting E*Trade and identified it as an “extreme stock” with a “Buy at $4, sell at $8” recommendation. In contrast, financial analysts have been so slow to respond to E*Trade’s “turn around.” A review of analyst upgrades and downgrades shows that the last activity was five months ago in December 2007. Quite the delay given recent developments.

What IS fast becoming the new consensus is E*Trade’s robust recovery in the online brokerage business: old customers are returning, new customers are signing up at close to a record high pace, and assets are growing again and at a faster pace than both TD Ameritrade (AMTD) and Schwab (SCHW). To E*Trade customers, this is of course no surprise, given E*Trades cutting-edge online trading platform: fast, reliable, and sophisticated, unlike some of its competitors who just last week had slow and stalled trading.

So, with these dramatic yet still little recognized fundamental developments, and with bullish volume and trading trends, WHO is going to trigger the "Magic Moment?"

Let's examine them one by one. (One word of caution, this is not a complete list and it can't be complete, for the Magic Moment, by definition, has an element of surprise.)

• Conventional Shorts?
• Box Shorts?
• Analyst Upgrade(s)?
• Fresh Buyer(s)?

Conventional Shorts: E*Trade has 111.4 million, which is over 22% of all outstanding shares, one of the top five most shorted Nasdaq stocks, in one word: HEAVY.

Of these heavy and numerous shorts, any sizable one can trigger the magic moment if it decides to wise up to the fundamental developments at E*Trade or gets nervous about the bullish trends and begins covering the short position. With volume at only 9.9 million shares yesterday, it would take 11 days for the short interest to cover. By behavioral finance, the worry of ‘WHAT IF “they” move before “me?”’ has extensive repercussions as 111.4 million shorts start to worry about their buddies.

Box Shorts: They are the special animal of shorts. There are no published data and none of the box shorts would do an ad for us telling us they have a box position. So we can only guess and estimate. By way of background, the 1997 Act has largely closed the DOMESTIC tax loophole in box shorting, but an overseas-based hedge fund can still use this technique, NOT for tax but for price manipulation.

Yes, manipulation. Some will argue criminal but it's used. Why? In depressed stocks such as ETFC, shorts know fully well that many other operators can push the price and trigger a squeeze any time. So some shorts also build long positions, hence the name box short, either to use them to cover their short margin calls or to sell them in hope of keeping the price low. In other words, their long positions are fighting tools. Once their long position is used up, they must buy and cover their remaining short interest.

Looking at Bloomberg mutual fund and hedge fund holders of ETFC, I noticed that one likely box short used to have over 20 million long shares but has cut half of them in the latest quarterly filing. What's left is only 10 million shares at their disposal in any potential future fight. Worth close watch indeed! If ETFC continues to warm up, those 10 million shares will NOT last very many DAYS, let alone weeks or months.

Analyst Upgrade(s): Let's just say there is no more downside in ETFC as far as analysts are concerned. Only one analyst that has a “BUY” rating on E*Trade, all other analysts have E*Trade at SELL or the Wall Street equivalent of SELL [HOLD] and none of them has yet to come out of the herd recognizing the many recent progresses that ETRADE has made. So, by default, there is only an upside to the analyst(s) position. Also, remember, for stocks like E*Trade upgrade to SELL from STRONG SELL, or from SELL to HOLD can be powerful, let alone an upgrade from SELL straight to BUY.

Fresh Buyer(s): If any of the first three types just discussed have an element of con and second guessing in them. In contrast, a “Fresh Buyer” is actually logical and easy to understand. As a company makes positive progress, has bullish indicators, and is yet still undervalued, some corners of the vast institutional world with assets under management in the trillions of dollars will start to give E*Trade some recognition by becoming a new large shareholder. According to Bloomberg data based on SEC filings, as of the latest quarter, Citadel has bought the most and is the largest holder. After Citadel, the heaviest buyers were names such as D E Shaw, Bridgewater, Davis Selected Advisers, Barclays Global, Deutsche Bank, and Vanguard.

Which will it be? Conventional Shorts? Box Shorts? Analyst Upgrade(s)? Fresh Buyer(s)? Only time will tell.

Disclosure: Long ETFC

Comments

[lucky lenny:]

Not only a "fresh buyer" - i'm looking for a fullblown merger w/ AMTD or Schwab - the need to merge is compelling

2008 May 29 04:15 AM

[ZenInvestor:]

Yes, there will be plenty of 'fresh' faces when ETFC proves the turn around is well established. I can't see the $4.00 price holding too much longer, and their platform, as well as their over 4MM accounts makes this company an enticing target.

2008 May 29 06:22 AM

[rossetti2000:]

I agree.

There are basic rules when shorting any stock:

First: those investors who choose to short a stock have to be ready for a long-term commitment, and the chosen stock should have relatively very little value.
Second: Shorting a stock should evoke the thought of becoming a penultimate risk manager. For example:
Before taking the "plunge", short traders should think about responding to a Dirty Harry–like question. However, instead of, "Do you feel Lucky," the question might be, "Can you handle the share price doubling." Short traders should not want to bail and sell at an insanely high price. Most players who trade short want to stick it out, to "invest" for the long term (like longs are prone to do). However, there is more risk for short traders, because large short positions are dangerous. Any sudden shift in opinion or momentum could pop the share price and rapidly devastate traders who are late to cover a short position.

Third: Shorts have to bear value investing in mind, and they have to remember that takeover values are related to market values. If a market is crazy, takeover values might be insane. In addition, shorts must be vigilant about certain "special events" and here are a few events to consider:

Recapitalization;
Share Buy Back ;
A takeover ;
A change in management ; and
Any similar event that might force a trader out of a short position.
If a short trader is holding a position and the particular stock starts going up, but not too wildly, a short (like a long) might choose to average in.

With the discussion outlined above in mind, let's take Etrade as an example. Let's hypothesize that a trader expects Etrade to go bankrupt under toxic mortgage debt and other financial pressures, and the trader shorts Etrade at $2.08 In January 2008. Then E*TRADE's share price moves rapidly to $3.00 a few trading days later, that short might assess special events before averaging in, such as:

1. E*TRADE's recapitalization (the consequence of the November 2008 Citadel bailout);

2. E*TRADE's share buy back potential (and it was clear that there was no such potential at the time);

3. A takeover possibility (At the time, chances of a merger were slim to none after the Citadel deal, because Etrade chose a bailout and it was left with a lame banking arm); and

4. A change in E*TRADE's management (there was no real change at the time except for Caplan leaving, and Layton becoming a figurehead chairman).

The average short trader might think that E*TRADE's HELOCs were a financial time bomb waiting to happen. In January 2008, subprime paper was a sure negative. Likewise, competition in the brokerage core was hard enough to contend with (e.g., Scottrade, Fidelity, BOA, Tradestation, etc.), without simultaneously contending with the extra heavy burden that had become E*TRADE's banking arm...so in late January 2008, even at $3.00 (a paltry price indeed), it might have been a wise decision to continue shorting Etrade. After all, the thought of E*TRADE's bankruptcy still loomed.

However, as we all know, at approximately $5.45 intraday in February 2008 (more than a doubling of E*TRADE's intraday low of $2.08), Etrade had almost made it up to $6.00, or nearly triple its lowest price.

But, in looking again at "special events" mostly everything about E*TRADE's status had not changed during its rise in share price to $5.45. While E*TRADE's general health might have improved, the improvement was certainly not enough to discourage short traders from continuing to average their positions on the way up. After all, without further news of great metrics (Etrade had reduced its metrics reporting from monthly to quarterly) how much more could E*TRADE's share price rise before the first quarter 2008 conference call? Therefore, short traders felt confident about adding to their positions and sending short interests into the stratosphere. In doing so, short traders accumulated total positions that would exceed the number of available Etrade shares to cover in the face of favorable special events.

However, special events mean more to a short's survival than they do to a long's eventual success.

For example in following the rules of shorting, short traders should keep the following question in mind: "Is there something out there, some news, and event, or a report that will take E*TRADE's price down, considerably?" Once short traders "buy into their short positions", their goal should be to hold their positions as long as they can. This is the paradox of shorts having to be "longer" than longs."

Therefore, in that long term short commitment, short traders have to keep their eye earnings reports and ask: "Will there be disappointment?" Short traders welcome earnings disappointment, especially in an overvalued stock. If the disappointment is big enough, short traders will pull the trigger and collect bountiful rewards.

To recapitulate, short traders look for the typical overvalued but growing company. Short traders do not take positions in companies that have real value, but they do take positions in companies that may have perceived value, or a rapidly sinking value relative to the current share price.

Short traders who follow the rules of shorting will not maintain a lengthy short position in any company where value is gaining on price.

On the other side of the coin, Etrade longs are convinced that E*TRADE's value is catching up with its price because:

1) Recapitalization has already happened with Citadel and recapitalization will continue with "front door" debt for equity swapping;

2) Share Buy Back seems more possible; E*TRADE's banking arm continues to strengthen and Layton might pull a Winter of 2008 surprise by plowing several hundreds of millions of dollars of no longer needed banking reserve into a share buyback program;



3) A takeover is looking better with each passing week, because the banking arm is becoming less of a problem and because Layton is "teasing" the toxic portion of it out of E*TRADE's financial makeup and business model; and

4) A significant change in management has taken place in 2008.

Once again, in assessing whether Etrade is a good candidate to keep shorting, the ever present question for short traders is "Do you feel lucky?" The translation here is, "Do you feel that you can short Etrade 'forever'?" Because long-term shorting is one of the cardinal rules for shorting a stock...a short trader must outlast a long-term investor holding similar positions.

There are a few other considerations for the short trader. One consideration is that shorting gains becoming ordinary income. Another worry is that if E*TRADE's share price rises considerably (i.e., presently, if it doubles to $8.00), a short trader's risk goes up with the share price. The short trader's risk increases exponentially, because Etrade (our example) becomes a considerably larger part of the short trader's portfolio. It is just the opposite for long-term investors; i.e., Etrade suddenly becomes a lesser part of a long's portfolio (a long can sell half of the shares and wind up with a welcomed paradox of taking the original investment amount out, yet leaving the original investment amount in).

So a word to those who are still brave enough to short Etrade...follow your cardinal rules of shorting; realize:

1) That E*TRADE's management has changed;

2) That Etrade is becoming more strongly capitalized everyday;

3) That E*TRADE's banking arm is healing and that the arm's toxic fat is disappearing;

4) That acquisition is looking better everyday;

5) That Layton could spring a share buyback program (large or small scale) at anytime he feels that he can release all or a portion of the conservative portion of E*TRADE's banking reserve;

6) That debt for equity swapping is now a reality, and that it will not be dilutive enough to cause a notable value drop; and

7) That E*TRADE's recent change in management was not conducive to a long-term rampage of shorting.

Those are the current Etrade shorting considerations.

In other words, realize that Donald Layton's supervision of E*TRADE's turnaround in Q2, Q3, and Q4 of 2008 will likely result shrinking losses and noteworthy gains for Etrade. Thereafter in following the cardinal rules of shorting, think about whether a possibility looms that Etrade will see $8.00 to $10.00 by January of 2009 (a doubling or better of the current $4.00 price). Lastly, reconsider whether any wise short trader will be able to be short, forever, if necessary (one of the foremost cardinal rules of shorting).

If the answer seems to be, "No," then rethink your positions and cover while you still have a realistic opportunity. Don't let the recent Proxy share authorization increase fool you. If E*TRADE's Board chooses to issue only a low number of those new shares, with restriction, E*TRADE's market trading shares may become very scarce indeed.

After all, how much more of E*TRADE's increasing value to share price movement (perceived or not) will a short trader be able to sustain in the long term?

2008 May 29 06:34 AM

[Jimmy Goodwin:]

/Awaits JB-Maria to tell you its all wrong.

Excellent article, spot on.

2008 May 29 07:28 AM

[Roxieanne:]

Cindy

You have what is known as intestinal fortitude with ETFC----in other words guts----good for you hope this works out well for you and others. Have it on my watch list---not short.

2008 May 29 12:15 PM

[jbmaria:]

Readers should know that Cindy Reed is abusing the process.

SA was set up to provide a voice for those without a platform for their views to make themselves heard.It's a good idea and I've read a lot of great articles on this site.

SA was not set up for people to shill their investments although I suppose every good idea eventually gets corrupted and Cindy Reed is simply taking the abuse to its inevitable level.

Some facts:

Cindy went long ETFC and decided to explain her position on SA in mid April.No problem there,essentially what the SA site is all about.
Then Cindy got a "bright idea". There's no real limits on SA,Cindy could flood the news with positive articles on ETFC and theoretically profit for her trouble by stimulating the stock pps.
So,our heroine marched over to the yahoo message board to actually recruit help in perpetrating this distortion of the process.
There she found other shills perfectly willing to join the cabal and promote the stock.Cindy trolled the board under the name savyinvestor11,the entire story can be followed by reading her posts:

search.messages.yahoo....

Her main partners in this blatant and undeniable promotion on ETFC are numbersssss and prescient11, other sympathetic and contributing posters include dig4gem, rossetti2000, methusalaw, piyrwsc, krisscritter_1, quasimatter and epiquette ,to name a few.
What these slimy folks are doing goes against the spirit if not the letter of the rules of SA.I don't like it and I'm going to dog them with this warning.
I have no position in ETFC after selling my last shares in June'07.I was a vocal long for 4 years before that and am currently a very vocal cautionary voice on the stock.All my posts can be found on yahoo under JBMARIA.




Here's the list of Cindy's pumps in chronological order:

Citadel Infuses E*Trade with Strong, Experienced Management
on May 29, 2008 about ETFC
Who Will Trigger E*Trade's Magic Moment - and a 111.4M Short Squeeze?
on May 29, 2008 about ETFC
Seeking E*Trade's 'Magic Moment'
on May 23, 2008 about ETFC
E*Trade: What the Analysts and News Haven't Told You
on May 22, 2008 about ETFC
Schwab, E*Trade: Monthly Activity Comparison and the Industry Average
on May 15, 2008 about ETFC, SCHW
E*Trade's Annual Shareholder Meeting Should Pressure the Shorts
on May 09, 2008 about ETFC
Comparative Price Shopping: Selected Banking, Mortgage and Brokerage Stocks
on Apr 21, 2008 about BSC, CFC, ETFC
E*Trade: Primed To Turn Around?
on Apr 18, 2008 about AMTD, ETFC, SCHW

2008 May 29 01:56 PM

[oregonduck:]

Is any analysis regarding a stock "pumping" that stock? I have looked at other sites that "pump" from Etrade that take me to this site that have forums on Visa, GE, Schwab--and they all seem to Pump the stock. Arent we all supposed to look at this information and make our own decisions?

BTW-- Since I fired my broker and started doing my own trading--I have made WAY more money because I actually do my own research and care about making money for me.

2008 May 29 06:48 PM

[jbmaria:]

You sound offended that I explained why so many articles are coming from this author about ETFC? Should I have said nothing?
Maybe I'm naive about SA procedures? Are you saying other authors go trolling for help on yahoo message boards in the hope of creating multiple pumping articles about a stock?
Enlighten me,who else does that and admits it?

2008 May 29 08:05 PM

[OKMONEY:]

Rossetti2000: Your comment was better then Ms. Reed's article.

2008 May 29 10:41 PM

[Plantinseeds:]

Yes I agree. Rossetti2000 did an excellant job on the breakdowns of shorts for not only Etrade but in general. And the very resonable, positive points made for Etrade also.

The only thing that I'm still clueless about is the short itself.

I thought that to short a stock was to bet/hope that the price went down. But have never really understood how someone actually profits from that.

Now as to Mrs. Reed, I have seen all her articles on the positive rah rah rah etrade and grew cautious because she never points out any negatives.

LOL she sounds alot like a guy that calls himself V****** on visa articles that is strictly rah rah rah go visa and wants not to hear anything negative even balanced posts about that stock.

Now I am long on both the V and etrade. I wish I had as much V as I did etrade lol. I was one of the dumbies that rode etrade all the way down.
If I knew how shorts worked, I don't think I would ever buy anything but a short. PGH and V are the only 2 stocks that I ever bought that didn't take a signifcant nose dive before they came back up (well not all of them back up and none of them very positive). :(

Again Rossetti2000 I have to say that your post was one of the, if, not the best posts I have seen on SA!

2008 May 30 12:39 AM

[PokerDonkey:]

JBMaria - I guess it just shows you how useless it is to pump a stock on SA.

2008 May 30 09:19 AM

[Ermilo:]

JBMARIA, I can understand how you feel like this is a "pump", but the reality is, people need to make up their own mind and be cautious of ANY material they read. I'm glad you are speaking your opinion, I'm also glad Cindy is doing like wise. Personally, I'm long Etrade, so I naturally look for others who concrete my idea. I just personally like her common sense approach. I find nothing that makes me think she is just Pumping the stock.

2008 May 30 11:38 AM

[jbmaria:]

It's a full disclosure issue. I just want people to know how and why these articles have evolved.
I'm willing to bet a lot of new readers had no idea of the planning and personalities that brought this sudden rush of ETFC "happy talk" in front of them.If there was a little more editorial discretion by SA,maybe everyone might be better off.

2008 May 30 01:17 PM

[daffy:]

I think that jbmaria ha the real problem here with promoting his/her investments. You can be guaranteed that is there is an article about ETFC, jbmaria will have a lot to say.

Yep the kettle is black. No other shade can prevail.

2008 May 31 07:46 AM

[dmilkman207:]

I would have to say the rossetti2000 comment was the best I have read regarding the huge short interest in this stock. I have found it difficult recently to imagine why institution or investor would be holding a short position in ETFC. It seems like the huge risks would outweigh the reward. Like rossetti said there are certainly a number of possible catalysts that could surge this stock. On the other side, the drag on the Company is the balance sheet issues related to their morgage debt. That seems to more than priced in at 4 bucks a share. You would have to think Layton was lying about the performance of the loan portfolio which I suppose has happened before with other companies in the past. The brokerage is clearly not going to do them in and I believe is going to earn them out of their current sitituation. That is why I am Long the stock and calls. But do your own research and dont let me pump pump pump it up!

2008 May 31 10:37 AM

[The Real Ex...:]

jbmaria: "If there was a little more editorial discretion by SA,maybe everyone might be better off."

Do you not realize that SA only cares to generate a trading mentality? They don't care about real content. You see, they want the same morons who watch Cramer. That is why they post his trash on the site. They are using the "Cramer" model - quantity, not quality and they get away with it because 99% of investors are clueless.

As far as rosetti's post, I have no idea why anyone is even giving "short" tips. No one should ever be shorting any stock unless they are professionals. It's far too risky. As a Wall Street professional, even I only rarely take pure short positions, and even then I always buy protective calls.

There are better ways to go short - using puts or Ultrashort ETFs. E-Trade has made so many think shorting is just a click of the mouse away and sadly it is. Unless you have worked on Wall Street you have no idea how risky shorting is. Virtually no stock brokers working for wirehouses are allowed to short stocks yet OLBs allow any moron to do it. Remarkable. And the stock market charade continues....and investors stand by watching, while they get screwed again.

2008 Jun 09 05:40 PM

[willytheg:]

This is slightly off-topic but I'm hoping that I can get a lead from your readers.

I got a re-fi on a primary residence from etrade when they still had a loan origination dept. This loan came with many verbal assurances about how the terms of this loan would be improved down the road. About 2 weeks later Etrade stopped making loans and kept a skeleton dept. with severely curtailed hours open to service existing clients. This has made doing business associated with this loan extremely difficult. Needless to say, any verbal agreements on which I was depending, are out the window.

I was looking for something of a nationwide group of etrade home equity clients that may have had similar issues.

Thank you for allowing me to post this request and I apologize for any breach of protocol.

2008 Jun 28 03:11 PM