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The deep decline in markets worldwide that has left many an investor in despair and has prompted some to take extreme steps like committing suicide seems to show no signs of bottoming out. A coordinated move by central banks to lower interest rates had no impact yesterday and central bankers appear as helpless as a child on her first day at school. As I usually tend to do, I was early in my expectations of an economic decline tied to housing as discussed in the hedging the economy through LEAP puts section of the November 2006 newsletter and am probably going to be early in turning bullish once again.

However there is a way to take advantage of the extreme volatility we are currently experiencing by making neutral bets using a couple of options strategies called straddles and strangles. We have used strangles in the past to profit from earnings related volatility in Apple (NASDAQ:AAPL) and I discussed using strangles in great detail in my blog post Getting Ready To Strangle Apple. Ironically I started that blog entry with the words,

If the 2000-2003 bear market was one of the longest bear markets in history, this resilient bull market, which has now lasted over 52 months also happens to be one of the longest bull markets without a meaningful correction. It is getting harder and harder to find good opportunities whether you look at different asset classes (stocks, bonds, real estate, commodities, etc.) or in geographically diverse locations.

The largest private bank in India, ICICI Bank (NYSE:IBN) drank from the same well that many of the banks in the United States did and as a result the stock has taken a very hard hit since the start of this year, falling from over $72 in January to its current $17. ICICI has also fallen with the rest of the Indian market, which dropped 45% over the same time period and on account of recent rumors questioning the financial strength of the bank. While management has strongly denied these rumors it remains to be seen if they are pure speculation or have some substance to them.

The Reserve Bank of India (RBI) has stepped up to provide enough cash to ICICI during the recent run on the bank just like it did a few years ago when ICICI experienced a run in 2003. Letting ICICI fail would be the equivalent of letting Bank of America fail in the United States. Following the 2003 run, ICICI went on to post spectacular gains. The difference between 2003 and now is that the bank had one of the greatest bull market winds on its back with the BSE Sensex quadrupling in value over the next five years.

Whether ICICI rebounds from these levels (current P/E is 12.91) or continues to fall further, the moves on either side are likely to be sharp and hence my plan to strangle ICICI with out of money options and a slight bullish bias. I am going to purchase the following set of options for ICICI both in the SINLetter model portfolio and my personal portfolio. The closing price of the day will be used as the purchase price for the model portfolio.

  • 5 Contracts of Jan 2009 $20 Calls on ICICI ((IBNAZ.X))
  • 5 Contracts of Jan 2009 $12.50 Puts on ICICI ((IBNMV.X))

As discussed in the October 2008 investment newsletter, I am also starting a position in Intel (NASDAQ:INTC) by purchasing 500 shares for the model portfolio. I will also add to my existing Intel position in my personal portfolio.

Source: Preparing to Strangle ICICI Bank