Options Trader: Wednesday Morning Ideas

by: Philip Davis

Shanghai Surprise?

Hardly. We’ve been saying for weeks that there are forces aligned trying to take down the China markets. Yesterday the Chinese government tripled the "Stamp Tax" on stocks in a move to "cool off" the market. While much is being made of this, it’s still only a .3% tax ($3 per $1,000) on each end of the transaction, so I think this may be much ado about nothing. Steven Sun, an equity strategist at HSBC Holdings plc (NYSE:HSBC) in Hong Kong, said in a note that the government is "clearly worried about the A-share bubble," but isn’t aiming to substantially hurt stock prices. "Hence the grand 'strategy' is to gradually deflate the bubble but not to prick the bubble," he said.
Shanghai Surprise

Notice they are worried about "the A-share bubble," not the B-shares they sell to we foreign devils. As I’ve been saying for weeks now, the growing disparity between the A and B shares is not sustainable. B-shares continued their decline, down another 9% yesterday to 302 after peaking out at 371 on the 21st, the same day I warned:

Even Hong Kong tycoon Li Ka-shing, one of the richest people in Asia, expressed concerns this week over the stock gains, saying he is worried about high price-to-earnings ratios that have created a "bubble." What is troubling is that most of these investors are new to trading stocks, yet they are going after lower-quality shares without considering the downside risk. "In the case of a severe correction, this could lead to social instability," warned Credit Suisse economist Dong Tao, in a report to the investment firm’s clients this week.

We put our money where our mouth was last week by pulling our long-held FXI leaps at what turned out to be a nice top, leaving just the covered play of the Jan $120s (basis $4.90) against the June $110s. We sold these for $3.70 and should get a nice payoff today. That being said, I may be flipping to a buy if Europe holds up as I think this sell-off is a bit of an overreaction to a tax that is less than a broker’s fee to small players. Let’s see how our own markets hold up, though, and much more importantly, how they react to the 2pm FOMC minutes.

Trade Deficit

China’s trade surplus is projected to almost double this year, to $300B and there is no denying the underlying strength of the economy. The National Development and Reform Commission said neither a stronger yuan nor cuts in export-tax rebates would shift export orders away from China, as the world’s fourth-largest economy enjoys pricing power in the global market. "It’s hard for importing nations to find replacements for [Chinese] manufacturers," the commission said. "It will be impossible in the foreseeable future to shift orders away [from China] on a large scale." That means Chinese producers can transfer most of their increased costs to importers (that would be us!). The yuan rose 3.25% last year while Chinese export prices increased 4.2%, the commission said.

Unlike our last China meltdown, today’s drop was taken pretty much in stride by the Hang Seng (down .86%) and the Nikkei (down .48%), while India dropped a point after three very strong days. If Europe can hold it together we may have to zero in on some China-specific stocks for a rebound. China Mobile Ltd. (NYSE:CHL) is often my favorite of the group and we’ll see how they handle the $45 line, but I was already liking the $45s yesterday as they dipped to $1.25, at $1 I consider them a worthy risk (using our momentum trade rules).

On Fire

Another not so surprising move came out of Europe as ONE country refused to accept a climate change treaty that was backed by the EU, China and India with the goal of putting a 3.6 degree cap on average global temperatures before taking emergency measures. Who could be against stopping global warming before temperatures rise 5%? Was it Russia (that Putin doesn’t care about the rest of the world)? No, they backed it. Was it Japan (they make all those cars and kill whales)? No, Japan was on board. Was it France or Italy (crazy socialists)? No, they signed. Surprise (or not) - it was US! James Connaughton, chairman of the White House Council on Environmental Quality, said the U.S. is not against setting goals but prefers to focus them on specific sectors, such as reducing dependence on gasoline and cleaner coal. "The U.S. has different sets of targets," he said. A different set of targets than 5% above the already rising average global temperature?!? We are so doomed!

European markets are down about a point as they prepare to crank up their air conditioners in another hot summer in early (8am) trading. We already lost the FTSE, but now I want to see the DAX hold 7,700 and the CAC hold 6,000.

Our markets are down in early trading too, but the China sell-off is a pretty thin premise for taking the markets down, so I’ll be considering this a shake-out ahead of Fed evidence to the contrary this afternoon. We still have our stops and I don’t mind letting go of some weaker positions, especially with lots of good buys shaping up. Micron Technology, Inc. (NASDAQ:MU) was a good one yesterday, but Marvell Technology Group (NASDAQ:MRVL) got away from us and hopefully we’ll get a shot at them on a dip this morning. If not, then we will be VERY glad we got our MU’s!



Day's Move

Must Hold

Comfort Zone

Break Out

Next Goal


















































Hang Seng 20,293 -175 20,200 20,600 21,000 22,000
Nikkei 17,588 -84 17,400 17,500 18,300 18,500
BSE (India) 14,411 -96 13,200 14,000 14,725 15,000
DAX 7,700 -80 6,900 7,000 7,400 8,000
CAC 40 6,003 -52 5,650 5,800 6,000 7,000
FTSE 6,549


6,325 6,450 6,600 7,000

US Markets

This could turn pretty ugly, so let’s be careful. We are almost certain to give back the green we gained yesterday on the Dow and the Transports early on, but none of our other indices are likely to cross today. So I’ll be looking to see if we get more than halfway to danger without a bounce on today’s moves. We really, really don’t want to see two European indexes turn red, but that will be resolved at noon, well ahead of the Fed minutes.

Pulte Homes, Inc. (NYSE:PHM) announced they will cut 1,900 jobs in restructuring and, for some reason, barely budged yesterday. Barry Ritholtz has the right title, though, as he says the "Housing Freefall Continues Unabated." I will, at this point, warn homeowners with small children to have them leave the room before you look at this chart, which may cause you to say something you don’t want them to hear:

Click to Enlarge
S&P/Case-Shiller Home Price Indices

Gosh, that’s a steep decline, gee I hope they don’t raise rates . . . too late sucker, they already raised rates as the 30-year note has passed 5% for the first time in ages and the 10-year note looks to test that level as well. Anything less than soft language from the Fed this afternoon is likely to break that critical barrier, effectively adding even more pressure to housing prices.

Zman was on a tear yesterday about the insane (and unsustainable) refiner crack spread and we’ll see today how Tesoro Corp. (TSO) responds to its new split price (big sell-off PLEASE!). This morning he is on top of things ahead of tomorrow’s delayed inventory reports (those one-day holidays make it impossible for them to add it all up by Wednesday I guess, not that they’re accurate anyway . . . ). That's where our man Flynn predicts a 2M draw in gasoline as ZMan theorizes:

. . . hoping to create a buying opportunity when the number comes out and it’s bigger and drives gasoline prices down (like last week). At that point you go on CNBC, who conveniently forgot how off your number was, and attempt to drive RBOB back up with tales of doom and gloom while videos of refineries burning are played just over your shoulder.

We’ll see how this little drama plays out tomorrow morning, but for today we will watch the dollar, as no 82.50 will mean no major downturn (I know, it’s all so counterintuitive) and gold below $666 means don’t worry, be happy as copper is sure to follow ($315 is the break point).


Be careful out there today!