Options Trader Monday Outlook: What a Way To Start the Week

Includes: DIA, SKF, XLF
by: Philip Davis

Wow, it’s a global market party (except China)!

Hank Paulson rides to the rescue(?) of the GSEs, saving them by destroying them.  You can read my last night’s post for my take on that and, as I said then - So what, big deal; how do we make money?  We are going to be happy to simply make BACK the money we lost last week as we stubbornly held on through the carnage, pretty much following the "Don’t Just Do Something, Stand There" section of our playbook.  One of the hardest things you can do in the market is hold onto a position while waves of market panic wash over you - it’s the hell of being fundamental traders to ignore the herd and focus on our goals…

It didn’t have to be a FRE/FNM bailout (in fact, we wish it wasn’t), we were waiting for a catalyst to turn the market back from a way oversold bottom (possibly forced) but we are far from out of the woods yet.  As Tommie Lee Jones said to Will Smith in Men in Black: "There’s always an alien battle cruiser, or a Corellian death ray, or an intergalactic plague intended to wipe out life on this miserable little planet. The only way these people can get on with their happy lives is that they DO NOT KNOW ABOUT IT!"  Investors are looking to get on with their happy lives today and we’re certain to get a good morning out of it but we have to question what has really changed and it it enough to give us more than a one-day short squeeze?

Let’s keep in mind that the UltraShort Financials (NYSEARCA:SKF) are going to be a great way to hedge our large amount of financials calls.  This is a 2x inverse ETF for the financials and should open today down  from Friday’s open.  It’s always a good idea, when you have multiple positions that are doing very well, to begin to set up a mattress play in case the gains start to drop out from under you.  A good way to backstop gains for today should be the Jan $90 calls for about $22 as we should be able to pick up 1/2 of that for selling the Sept $90s against them if things keep going up and up.  Then we can use that $10 to roll our longs up another $15-$20 which allows us to let our open financial calls run a little longer without covering them.  Similarly, our fully covered DIA long puts will have their callers wiped out and we use that money to roll our long puts up to higher strikes, which allow us to enjoy the ride on our broader portfolios.

Our smaller portfolios are uncovered and we have to balance our our fear and greed impulses here and remain fairly dispassionate about this morning’s gains.  Let’s remember where we were last week and how lucky we are to get a nice recovery.  It still may be time to start rolling our positions further out in time, especially as our front-month calls will outgain the longer months we look to roll to.  While this rally may have some legs (last time the Fed stepped in in mid-July, the XLF jumped 35% in 5 days) we have looming resistance at $25, which is up 50% from our July 14th lows and needs to be respected so gains of 20% on our financials should, as a rule of thumb, be covered or rolled or taken off the table as this is not a game-changing solution.  As Bloomberg says, this is stopgap at best

The broader market jumped 800 points (7%) in 5 days off the July 14th lows and that would bring us up to the magic 12,000 mark and that is still shy of the 200 dma at 12,300, so the 50 dma at 11,400 is the spot to watch on the Dow.  We should open higher than that so it’s all about our continued momentum, finishing anywhere less than the highs of the day will make us more cautious into the close but, for now, the futures are looking bright so let’s just enjoy the ride.

Asia rode the irrational exuberance up about 4% this morning with the Hang Seng jumping 860 points and the Nikkei adding 412, but neither index is in very impressive territory.  Not at all impressive was the 2.7% DROP in the Shanghai Composite, now down 64% off their last year’s highs.  While banks in Japan were going limit up (indicating more room to run tomorrow) thanks to US Federal intervention that removed $5Tn worth of uncertainty from the financial markets (global central banks were on the hook for close to $1Tn with our GSEs), Mainland China’s markets fell over a lack of expected intervention on behalf of their government.  The yen fell lower as carry traders plowed money into US futures but it remains to be seen if this Treasury action ends up weakening the dollar.

The good news is, unlike the last stimulus package, this one is not directly inflationary and, in fact, should make our treasury bonds more attractive, keeping rates down without pumping up the commodity bubble and giving the Fed room to at least talk tough on the dollar if nothing else. 

Europe is also up well over 3% ahead of our open but the LSE’s trading system overloaded and had to be shut down and are still being restarted (8:30) so the shorts are wetting theirs as they wait for the exchange to come back on line.  "The bailout of "Fannie Mae and Freddie Mac has reduced the risk of a spiraling U.S. mortgage crisis and therefore has made the world a safer place for global investors," said the foreign exchange strategy team at Commerzbank. "Clearly, the knee-jerk reaction from this announcement is a sudden and massive increase in risk appetite," said John Hardy at Saxo Bank.  However, longer term, there are fears that this could reverse. "There is an implicit inflationary threat here too and if this leads the Fed to accelerate any tightening of monetary policy then it could prove to be the most expensive stopgap measure in history," said James Hughes, analyst at CMC Markets.

Oil is up $2 this morning to $108 as hurricane Ike heads for the gulf and OPEC began a meeting that NYMEX traders are hoping will lead to a production cut.  Failing to get firm cutbacks from OPEC and a miss by Ike could send oil tumbling below $100 a barrel by the end of the week, especially as almost no one needed to hit the SPR after the last hurricane, even though the offer is still on the table as the US is simply oversupplied with crude. 

The question is going to be, are we now oversupplied with debt as the US taxpayers are forced to guarantee Bill Gross and others who gambled on GSE bonds during the crisis they caused, effectively leaving them holding Trillions of dollars in bonds with effective high yields (+0.9% to Treasuries at the moment) that are now backed by the US government (using your future earnings, of course).  This also throws the CDO market into turmoil as $1.5Tn in credit default swaps may have to be unwound.  Should Paulson not wrangle concessions from these bondholders, it will probably go down as one of the greatest abuses of the financial system in recorded history, as that interest will be paid year after year by US taxpayers for decades to come - Grand Theft America!

What a way to start a week!