Options Trader: Which Way Wednesday?

by: Philip Davis

Well, we got our global rate cut!

Only half a point though. The question is - will it be enough to give us a boost?  If we loosely define boost as not falling another 5% at the open, then yes, it already worked as first the EU markets have already turned off an 8% drop at the open to head back to almost positive territory (for the day, we are still down 8% for the week) .  The news came too late to save the Asian markets, with the Hang Seng dropping a sickening 8% and finishing as the day’s low, down almost 20% since 9/22.  The Nikkei fell over 9% with a horrible finish, and once again we have to worry if our governments are coming in with too little, too late.

We need to cross back over 9,800 on the Dow in order to take a "recovery" seriously, and anything under 10,000, a full retracement of yesterday’s loss, is still bearish.  Nonetheless, we had a bullish set of ultra-longs picked out in yesterday’s member chat and it will be a good idea to review them and have one or two ready to fire off if the market keeps heading higher. 

If we do manage to get a bounce, my preference goes towards avoiding the premiums of the ultras and perhaps speculating with good old DIA Jan $91s, which closed at $9.88 and are roughly half premium, so after a 400-point gain you start gaining about $1 per 100 Dow points up and the front month contracts are very fluid and easy to cover with.   Even Nov $102s, which were $7 out of the money last night, were selling for $3, not a bad 5-week return on $10 for a caller you are $11 below.  Of course I’m not advocating a spread, but the idea is to cover with whatever gets you $3 or $4 when the rally runs out of gas. 

Another fun way to play the turn is to short the FXPs, which are the China ultra-shorts. FXP, which we played long as a cover, went from $95 to $130 in 2 days and the Nov $200 calls can be sold for $12.50.  That’s about a 25% move further down in the Hang Seng from here!  Current $105 puts were last sold at $5.95, not a bad return if we retake even half of the last two day’s losses in the China markets.  Also at meltdown prices are our old friends the SKFs, where you can sell the Nov $200s for $12.70, those also assume another 25% drop in the financials.  Also on SKF, I like the spread of the March $120s/Nov $130s at $44.90/28.20 as holding that protection for $16.70 through March is a great way to protect against another wave of finanical meltdowns (keep in mind the Great Depression scenario we discussed last night) and, if things go the other way, being in for $16.70 with a $10 plus 4 month position advantage does not make for a bad spread. 

These are, of couse, contingent on the Dow first crossing 9,800 (a good time to enter) and then 10,000 (if they hold it, these don’t need to be a day trade), at which point 10,000 can be once again used as a stop.  I’m not entirely certain we will get over 9,800 so easily now that we fell below it, and 10,000 is going to give us a lot of upside resistance.  Our Fed is not just cutting rates, they also announced yesterday that they are making $1.6Tn in loans available directly to corporations - the first time since the Depression that this has been necessary, indicating just how deep this crisis is already cutting.  The UK is undertaking its own massive bank bailout on a MASSIVE scale, directly purchasing $88Bn in preferred stock from British banks, guaranteeing $437Bn for bonds issued by banks and providing an additional $350Bn through the Bank of England’s "Special Liquidity Scheme."

I can only think of the phrase "Desperate times call for desperate measures" as these measures are very desperate indeed and we may be running out of time as well as Federal ammunition. Japan’s rates are already so low that no cut is possible, and ours are now down to 1.75% - not too many cuts left in that number!  Gold is still a good idea, as all these rate cuts coupled with the UK putting close to 1/2 of their $1.9Tn GDP on the table in one day is the kind of thing that can lead to hyperinflation, which can send gold skyrocketing.  We’ve been looking at GLD plays since last week’s downturn and it feels a little late now that it’s back over $900 this morning, but I’m not talking $1,000 gold inflation, I’m talking $2,000 gold inflation, and that makes the 2010 $110s at $9.10 a reasonable hedge against disaster. They are a 10-bagger if gold does get to $2,000 an ounce but should hold $5 all the way down to $750 (short-term), which doesn’t seem very likely with this level of panic. The logic of a trade like this is you take a 10% position with a stop at a 30% loss so you risk 3% of your cash as insurance against a catastrophe. 

You can couple a catastrophe play with a speculative play on one of the upside positions, especially as now that it’s 9am the markets have headed back down and are providing great entries on the plays I just mentioned as well as the ones we discussed in chat yesterday morning.  The upside is still absolutely the speculative bet and, if this move by the global banks doesn’t help, it may really be time to throw in the towel on these markets.

We get pending home sales today and 1 in 6 homes are now "under water," meaning the occupant owes more than the home is worth, which tends to keep those homes off the market for a while but ultimately can lead to far more foreclosures as people who can’t afford to pay for their homes can’t afford to move out either. 

September Retail Sales are not looking good either but Wal-mart WMT had a 2.4% bump, despite having to close 341 of its stores during the hurricanes.  Sam’s Club saw a whopping 4.6% increase in sales over last year and WMT projects a 1-2% rise again for October - yet the stock is trading down at $54 and looking weak!  Costco (NASDAQ:COST) reported an 8% rise in sales and beat earnings this morning with a 13% rise in revenues and a 19% increase in profits, yet they are trading down 8% in pre-market and would be my top choice for the day if the rest of the world wasn’t falling apart.  As I said yesterday, what is value, really, when the markets are in turmoil?

I think we are seeing panic, but there’s no telling when that panic will subside.  If we can’t put in a bottom today and recover to hold back over 9,800, we may be a long way from any sort of proper bottom and those downside plays will be great moneymakers. I can’t imagine what solace that will be, though, in a world where the markets are that devastated.  

I will leave off with a positive note.  In addition to beats last night by by Sealy (ZZ) and YUM, this morning there were earnings beats announced by Acergy (ACGY), COST, Lindsay Mfg. (NYSE:LNN), Merix (MERX) and Monsanto (NYSE:MON) (who lowered guidance) and Helen of Troy (NASDAQ:HELE) is the only miss of the morning while we wait for Progressive (NYSE:PGR) to report.  In a normal market, this would be good news, but there is nothing at all normal about this…