Options Trader: Tuesday Morning Ideas

by: Philip Davis

We’re having a China Syndrome type melt-down this morning!

The Shanghai stock exchange dropped 9%. Yesterday morning I said "his (Greenspan’s) most interesting statement is that investor appetite for risk has led to risk premiums on financial assets being 'extraordinarily low,' which could pose problems in the future." While the U.S. traders may have generally ignored Greenspan’s comments yesterday, Asian investors took it as a sign to take a little off the table and did so with a vengeance early today.

"Investors are choosing to cut their positions to avoid the fluctuations in the market, but it’s still too early to say the market has reached its peak," said Chen Huiqin, an analyst at Huatai Securities.

A 9% drop is VERY bad over there as they have a 10% limit down on Individual securities so that indicates a pretty broad and nasty sell-off. All of Asia was down 1-2% in sympathy except Taiwan, who somehow managed to gain a point. Airlines got clobbered and we need a clobbering to save our British Airways plc (NYSE:BAB) puts - I’ll be taking a very non-greedy exit there if I can!

Let’s keep some perspective as this is a 9% pullback off a 183% 18-month run, and this drop was so widespread that it very well may have been program trading catching up after a week-long holiday. We’ll have to wait an see how our markets react (like scared rabbits so far this morning) and what kind of follow through Asia has tomorrow before we throw in the towel over here.

Europe is a nice, mature market and is taking a nice, wait-and-see attitude this morning with only a slight sell-off, but our futures are looking terrible (7 am). In a move that may finally goose our American International Group (NYSE:AIG) leaps, French reinsurer SCOR (NYSEARCA:SCO) is attempting a hostile takeover for Swiss reinsurer Converium Holding AG (NYSE:CHR). "The unsolicited proposal fundamentally fails to recognize the value of Converium’s franchise and growth prospects, and is, therefore, not in the interest of Converium, its shareholders and its customers," it said in a statement.

Any time something like this goes on, it draws analysts attention to industry fundamentals and I’ll be adding to our AIG Jan ‘09 $70s at $8.50 or lower, hoping for a move here, still a light position until we’re ready to sell against it!


Back home, we have legitimate problems of our own as bank reserves to cover bad loans (like the record number of sub-prime loans that are getting record default rates) are now at the lowest level since 1990. Banks set aside an average of 1.09% of the total value of their loans at the end of last year, according to data from 518 publicly traded banks compiled by SNL Financial for The Wall Street Journal. That is a dip from 1.14% in 2005 and from 1.63% in 1992 and 1.48% in 1990.

"There is a growing concern about loan quality and it isn’t reflected at all in the reserves," says Brian Shullaw, an associate director at SNL, a Charlottesville, Va., research firm that focuses on the financial-services industry. Freddie Mac (FRE) is saying "no mas" to sub-prime loans and tightening the requirements under which they will buy those loans in the secondary market.

SunTrust Banks' (NYSE:STI) reserves are just .81% and First Horizon National Corporation (NYSE:FHN) has set aside just .87% but Washington Mutual (NYSE:WM) is way down at .6%! Adequately covered (hopefully) lenders are Citigroup (NYSE:C) (1.32%), Bank of America Corporation (NYSE:BAC) (1.28%) and JPMorgan Chase & Co. (NYSE:JPM) (1.51%).

I think this is a good enough reason to give the SunTrust Banks (STI) Apr $85 puts a shot at $1.50 as their CEO just stepped down anyway. FHN was already looking toppy at $45 and the Aug $40 puts for .80 may turn into an income producer if all goes well (or badly, as the case may be!). WM has already been punished with a 5% drop since last week so we’ll leave them alone…

Another problem to watch out for is the Durable Goods Orders for January, which came in down 7.8% and down 6% without the volatile aircraft number. This is WAY worse than expected!


We’re back to hoping we can hold bottoms today, very sad:

• Dow needs to hold 12,550!
• Transports need to hold 2,850.
• S&P needs to hold 1,440.
• NYSE needs to hold 9,300.
• Nasdaq needs to retake 2,460.
SOX 470 must hold.
• Russell 800 would be a disaster - especially since I let go of my iShares Russell 2000 Index (NYSEARCA:IWM) puts yesterday!

US Markets

I’ve been saying since Thanksgiving, we may be getting a correction all the way down to 11,500 before we can go meaningfully higher and I’m sorry to see it beginning (if it is). Let’s keep our eyes wide open and cut what we need to if we blow these levels.

We’re still looking for oil to break down below my target of $60.50 before we get too excited, but the seeds of demand destruction are well sewn - so let’s hope to do some reaping on these overpriced oil plays. We have plenty of target positions in our existing portfolio. I took a DD in the morning yesterday but there’s still a lot of leeway in some of our short-term plays if we can break down below $60!

If you want to learn something about oil - take the time to read ZMan’s excellent analysis of the OIH today! He points out that EPS growth is slowing for the component companies who are hammering the E&P companies with cost increases anyway. "Something’s got to give," he says and I wholeheartedly agree!

I may want to use PetroChina Company Limited (NYSE:PTR) as a buy if it gets hammered on China news today. They are already down from $142 where we made good money shorting them in January, but Buffett likes them at $120 and so do I. I’m hoping we get a retest of $115, but these guys actually go and look for oil. They just found a Billion tons of it in Daquing and another Billion tons in Tamuchage (I have no idea how many barrels that is but I bet it’s a lot!) and they are sitting within driving distance of the World’s fastest growing consumer market for oil (did I mention they have government backing?). We’ll keep an eye on this one for a good play…

It turns out the BOJ vote on rate hike was split, with three of six board members voting to keep rates down. This should give carry traders a nice boost of confidence as it lessens the chance of another rate hike coming soon. The dollar was under pressure yesterday and we’ll have to see if it can recover off 84 during this panic market.

Gold still needs to break $690 if it’s going to get to $700 (duh…) but it better do it soon or momentum will evaporate. If gold follows stocks and the dollar down then we know we are watching a deflating commodity bubble rather than a global equity panic - the two are very hard to tell apart with commodity stocks making up over 20% of the markets!

Oil and Dollar


We’re going to be careful today, but there is no reason to panic:

Let’s watch our FXI puts and try to bracket down our caller. From a portfolio perspective, I’m pretty excited about this as we only have 41 uncovered calls against 40 straight puts and and eight calls we sold in our short-term portfolio. Only seven of our uncovered puts are March and, other than Apple (NASDAQ:AAPL), which we already got half out of, those were already in bad shape anyway (that’s why we were stuck with them).

The worst hit might be our new Goolge (NASDAQ:GOOG) $480s and it will be interesting to see if I did save us some damage by moving more out of the money. Like I always say, if you’re going to lose money - at least try to learn something!


Speaking of hits - you know those bombs the Iranians are supplying to Iraq? Funny story… turns out they are made in Iraq after all:

U.S. Find Stokes Fears Of Iraqis’ Bomb-Making Ability

February 27, 2007

BAGHDAD, Iraq — An American military raid in southern Iraq uncovered a makeshift factory used to construct advanced roadside bombs that the U.S. had thought were made only in Iran. The find raises fears that Shiite Muslim insurgents across Iraq may be able to manufacture large quantities of such weapons on their own.

This certainly doesn’t let Iran off the hook (where do they get the parts?) but we do need to perhaps think just a bit before we jump to conclusions, especially when they lead to new wars…. I bet the oil markets won’t like this as it may cause us to lose one of our main attack Iran premises.