Options Trader: Wednesday Outlook

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Includes: AIG, BAC, C, DIA, DUG, ERY, F, FMCC, FNMA, MTLQQ, OIH, WFC
by: Philip Davis

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This is getting very interesting!

As we expected in yesterday’s morning post, the morning pump was a great selling opportunity and we had a very good time riding the gentle dip we got in intraday trading. The Dow hit its high for the day at 10:03 and by 10:09 I had an alert out to members to ignore the consumer confidence number and go more bearish on the Dow, buying back the Sept $95 puts we sold Monday for a quick 20% profit. We also grabbed the OIH $105 puts for $2.30 that made a nice buck during the day (43%) and we entered a couple of spreads on ERY at 10:57, well ahead of oil falling off a cliff in the afternoon.

Great call by David at the Oxen Group on making DUG his long of the day yesterday with a perfect buy in at $15.10 and hitting the 4% goal for that day trade. It was David’s call that inspired us to pick up the very profitable (and much riskier) ERY trades, which were also an idea of his from an earlier trade so mega kudos to the Oxen Group!

We got a second rally on low volume around noon and my 12:09 comment to Members was: "Still a very good time to look at some of those long put plays we discussed in yesterday’s morning post" so I guess you can say we were still pretty bearish at that 9,600 line on the Dow. Keep in mind that the top of our prior trading range was 9,100 on the Dow so the 5% rule off that mark takes us to 9,555, which was where I predicted we’d close. We had a good chance to press our long DIA covers higher but we feared the overnight stick and we went with a 1/2 cover on our long puts, selling the DIA $95 puts for $1.75 just in case we have another crazy pre-market pump.

As you can see from David Fry’s S&P charts, we are "outside the box," very much as we were in June but note that we held that level (S&P 950) for quite a while before getting a 10% correction into early July. I’m not getting the feeling that we have enough energy to sustain us up here that long but, the way things have been going, we kept all of Monday’s bear covers in longer timeframes because as Chantale very aptly put it: "It's hard to predict when somebody on coke will stop dancing."

The markets have indeed been out on a bender and, like our coke dancer, we know there’s going to be a crash, we just can’t say exactly when it’s going to happen. One sign that the party is ending is what we had yesterday when "good" news like a big jump in housing prices and the reappointment of our dollar dealer, Ben Bernanke, wasn’t enough to punch the market to new highs. Is it possible that we’ve finally hit the point where we can’t get any higher?

"If there was ever an argument to be made for the NYSE having turned into a gigantic ‘hot potato’ parlor game, this is it," notes Karl Denninger as he looks at 4 stocks: C, BAC, FRE and FNM who, with 2.1Bn shares traded yesterday, accounted for 37% of the total market volume. Karl points out that FRE and FNM are arguably worthless and I would add to his list GM, whose stock is still being bought and sold by the hundreds of millions of shares EVEN THOUGH the government and GM itself has repeatedly warned people that the shares are worthless. As Karl says: "Now folks, let’s be straight here. Do you believe for one second that this is "great liquidity" added by the "high-frequency trading" computers that are almost certainly behind the vast majority of this volume?"

A little faith is a good thing. We had faith in AIG, F, C, BAC, WFC and dozens of other stocks when they were near zero in the spring but faith can get you killed if you believe you can walk into a burning building or breathe underwater or hold GM for a profit. Well, maybe that last one won’t get you killed unless you borrow money from the mob to buy the shares… Either way, we are no longer talking about grabbing 1,000 shares of FRE or FNM for .40 ($400) and seeing what happens with a stop out at .20. In yesterday’s trading 236M shares of FRE and 676M shares of FNM were bought for about $2 in companies which are actually owned by the government now and have virtually no chance of ever emerging from their debt. PT Barnum would be proud because, between the hours of 9:30 and 4pm, that works out to 2,338,461 suckers per minute!

As I mentioned last week, this is reminiscent of 1999 when a sock puppet selling pet food was given $500M for a business model that had less chance of turning a profit than my daughter’s lemonade stand (and we only have 24 homes on my block!). FRE lost $34.60 per average $15 share last year and is losing $6 per $2 share this year and next year they PLAN to lose $3 per share and they have $46Bn in cash and $850Bn in debts and they borrowed another $67Bn last quarter as their "investments" lost $84Bn in value. At $2 per share, investors are paying $1.3Bn for the joy of owning this mess. I’m not looking to pick on FRE - heck we bought them 2 weeks ago but we bought them based on the greater fool theory and we got right out as they rose. As Denninger says, it’s a great big game of hot potato…

Oil got dropped yesterday and fell right from $75 back to $71.50 in a fine example of our 5% rule and the weak finish indicates that they are likely to trend lower today. Aside from my general theory that the global economy simply can’t afford to pay $75 a barrel for oil there is also some very compelling evidence from the Baltic Dry Index, which fell yet another 2% today to 2,388, that global commodity shipments are not all that the media would have you believe. My logic in the rally up was to watch this index and it was clear in the spring that "somebody, somewhere was buying something" as the index climbed from 1,463 to 4,291 but now we are down almost 50% off that top and that means that nobody anywhere is shipping anything - something that would generally be considered "not good" by rational investors.

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