Options Trader: Monday Outlook

Includes: DIA, QQQ, SPY
by: Philip Davis

Xian posted a quote from the WSJ that is typical of the hysteria that is being thrown out as us from the press: "More than half of the nation’s $2.6 trillion of municipal debt, meanwhile, is guaranteed by bond insurers like Ambac Financial Group Inc., MBIA Inc., and Financial Guaranty Insurance Co. Because these insurers are also on the hook for billions of dollars in troubled subprime-mortgage-related bonds, their guarantees are no longer worth as much. Concerns about the credit ratings of the bond insurers are filtering into muni markets." TRILLIONS! What a fun number. But, when you think about it, isn’t this really the same thing as saying "Many life insurance companies are having trouble, therefore Billions of people will die!"

Losing your life insurance doesn’t make you any more likely to die than when you were uninsured, it just removes a safety net. While there may be some municipalities that default on their debt and the lack of insurance may harm some bondholders, there is no reason to think the rate of defaults on this $2.6Tn is going to exceed the historic norm of less than one quarter of one percent of all municipal debt. Additionally, 68.33% of defaults end up being recovered through debt service payments as few municipalities want to be seen as deadbeats.

Just as if I told you that the life insurance agencies had gambled their reserves on sub-prime mortgages and lost (and many did!), you would not jump to the conclusion that people all around you would start falling over dead. The loss of insurance makes people no more likely to die and bonds no more likely to default than the day before and this ridiculous hysteria over the situation really needs to stop!

The madness didn’t stop in Asia this morning as the KOSPI dropped 3.3%, Australia dropped 2.1%, India hit the 5% rule, Hong Kong came back from a break to drop 3.6% and the Nikkei continued their slide with another 1.4% dip, still holding that 13,000 line by 17 points. Japan’s machinery orders may have hit a bottom in December as forward expectations are turning up.

Europe is flat to mixed ahead of our open with SocGen scrambling to raise $7.9Bn, announcing new writedowns AND RAISING ITS NET PROFIT FORECAST FOR 2007! No wonder they are confused in Europe… The G7 is no hope as those guys have been downright gloomy this weekend but even I’m confused after reading this very mixed outlook. Let’s remember that economists and analysts are mainly working with the bankers and the financial institutions and those guys screwed up BIG TIME so everything looks screwed up to them. As I pointed out last week and again in the wrap-up: show me the misses! The global economy is still strong, even more impressive for not being taken down (so far) by a financial disaster that dwarfs the S&L crisis under Bush the first.

Bush II’s latest round of tax cuts for the rich, which were sneaked through in the form of "business tax cuts" in last week’s stimulus package have already been recalculated to cost us 3 times more than the government said they would as, according to the WSJ, "The difference comes from the failure of the government to take into account the "time value of money" when calculating the cost of tax breaks that allow companies to take deductions immediately, instead of spreading them over several years… In the interim, the U.S. Treasury must borrow to make up for the lost revenue. These interest costs over the next decade will triple the estimated long-term cost of the proposed business tax cuts."

Congress passed a nearly identical "bonus depreciation" tax break in 2002 that lasted for almost three years. Two studies of that break — by the Federal Reserve Board and a pair of economists at the University of Michigan — found businesses didn’t significantly speed up purchases of equipment. Instead, most of the tax break went to companies that were planning to make purchases anyway. As usual, the administration creates a crisis (or allows one to occur through inaction) in order to shove their insane spending agenda through before anyone has a chance to really examine the long-term damage being done to our country.

(NYSE:BAC) and (NYSE:CVX) are being added to the Dow! (NYSE:MO) and (NYSE:HON) are coming out! This is the first change in the Dow since 2004 and I’m furious that they haven’t replaced (NYSE:GM) with (NYSE:TM) as I keep lobbying for but it’s a great time to be weighting another financial, especially one that has been as unjustly beaten down as BAC. CVX was removed in 1999, when oil was $10 a barrel but adding another big oil company at this level does make me a bit nervous. GE is the only company that’s been in the Dow since it’s inception in 1896 and, on the whole, this is a hell of a strange time to make a move like this as it’s bound to cause some market turmoil.

Speaking of turmoil, our man Chavez is threatening to cut off oil sales to the US as he battles with (NYSE:XOM) over the ownership of Venezuelan oil fields. XOM has won court orders freezing Venezuelan assets in US and UK courts in order to ensure payment if Exxon wins an arbitration case over the issue. Chavez is threatening to not sell oil to the US, he will instead sell it to other countries who will buy less oil from other OPEC nations who will ship their oil to the US. This however, does explain the sudden rise in oil on Friday and is a fantastic reason to short it today (sorry CVX/Dow) as it will have no net effect on the energy situation at all. In fact, OPEC would be thrilled if Chavez would voluntarily cut back so they could sell some of their own 3Mbd production surplus. DIG $89 puts are $6.80 with just .50 in premium and DIG was $4 lower on Thursday morning so I like my odds with a stop at $5.50, looking for a modest $8+.

YHOO has rejected MSFT’s offer and we’ll be sending some nice men in white suits over to round up the board but you have to at least give it to them for posturing. MSFT (NASDAQ:MSFT) probably wouldn’t have offered $31 if they weren’t willing to pay $33 but I think it stops there.

It’s going to be a fun day in the markets, let’s hope the week is kind to us but I think it’s going to be fun!