Unconventional Way to go long Financials

Once-proud financial-service companies have been humbled, and currently trade at lowly prices usually reserved for unknown, unremarkable companies.

Citi (C) ended at $2.31 at Monday's close. American International Group (AIG) closed below a dollar. Both stocks are up roughly 250% off of all-time lows, but the future of the shares (and companies) are hazy at best. Risk-adverse investors don't necessarily want to gamble on such risky companies, especially while daily price fluctuations are so extreme. At the same time, however, bullish investors may want to be exposed to potential upside in shares of such trampled companies.

Rather than owning the shares of stock, investors could gain exposure to upside movement by selling naked put options.

Selling "naked" puts refers to selling puts without actually being short shares of the stock, which would sometimes create a riskier situation for the seller. However, with C shares so close to $0, even the worst-case scenario is very clear.

When puts are sold, the seller's account gets credited with the amount of the sale and an outstanding obligation shows up. If shares do move lower, the size of that obligation increases as the puts increase in value, and the seller essentially loses money. If shares increase in price, the size of the obligation gets smaller, and the seller enjoys some paper gains.

Below is a table of C January 2010 puts (courtesy of Marketwatch.com)

Though there is little to no volume in the far in-the-money puts, the bid and ask spreads remain reasonable and transaction costs do not inhibit using this strategy. Options close to the current share price retain time value, providing a bonus for the seller.

At the $2.50 level, options traded hands yesterday at roughly $1.25 (we'll take the bid), implying that investors expect C shares to be worth no more than $1.25 in January of 2010. If shares close below that level, the put seller will lose money. If shares became completely worthless ($0) before then, the put seller would essentially owe $250 per contract while he was only credited $125 at the time of sale. However, if shares only appreciate 10% (to over the $2.50 strike price) within the next 10 months, the seller will get to keep the entire credit at the time of sale.

Utilizing this strategy with in-the-money options changes the risk and reward involved. If a seller sold $10 puts for $8.05, he has a possibility of making $800 per contract (if shares close above $10 in Jan '10) while only potentially losing $200 (if shares go to $0).

Selling even farther OTM puts exaggerates the risk/return profile further. Selling $40 puts in the bid/ask spread at $38 seems possible, even though its highly unlikely that C shares will see that share price within the foreseeable future. However, the trade can still be made. Again, downside risk is limited to coughing up $200 if shares hit $0 (which means repaying $4000 compared to an initial credit of $3800), while profit potential remains intact (a $10 share price close would net the seller $800 of profit, essentially). And with C, AIG, BAC, and many other companies trading relatively close to $0, this strategy can be employed for an entire portfolio of companies.

Requirements for selling naked puts differs based on broker, and the strategy isn't for everyone. Like owning shares, downside risk is limited (paying the entire difference between strike price and $0) if the shares become worthless, but gains are capped too (at the initial selling price of the contract). But this strategy may offer an interesting way to expose one's portfolio to the possibility of bullish performance without sacrificing too much capital.



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Out with the Old, in with the New

I closed FRE around $12.50 and closed CIT around $7.80, both for ~$1/share gain over my entry points. If I would have held until the end of the day, I would have made about twice as much... but if I was still holding now, I'd be in bad shape.

I bought NTRI $12.5 July call and $7.50 July ODP call (shares had been crushed after advising that sales were very, very sluggish).

I’m playing the dead cat bounce with ODP while NTRI seems to be drunkenly staggering out of oversold territory. USO puts still open, and those have bled a little today.

Also bought CSCO Aug $22 call for $.90 when stock was at $21.60 yesterday, dropping 6% on the day. I figured it was oversold.

Why not try to take advantage of some market volatility?

Closing Positions

I sold my little CIT and FRE stakes yesterday into the strength at the end of the day. I don't not believe in their future prospects, but I'll take quick gains in the face of future uncertainty.

As a whole, the rally looked like short-covering to me... The parabolic gains heading into the close are one indicator, as people aren't usually as eager to initiate new long positions at ever-higher prices as they are willing to cover their shorts. Also, the performance seen yesterday from dogs like CROX indicates that many shorts may have thrown in the towel.

I'm still holding USO $104 Jul puts, and I'll see the value of that decline today as oil seems to be recovering modestly. If the inventory report at 10:30 is super bearish, oil should continue its slide; otherwise, it too may be pumped back up.

Earnings Season: Like Goin' to Vegas

As earnings season was in full force over the past week, investors were taken for a ride on a bucking bull.

I had a lot of fun and made a little money at the craps table, er, I mean, playing options of companies releasing earnings.

Early in the week, I took a bullish stance on Intel; they pleased the street and I came out ahead. Later, I also placed a bullish bet on eBay, but their earnings were not lauded by analysts (though I liked the release; more on that in another post). Thankfully, a 15% OTM put on SunPower (SPWR) just touched the moneyline, making my options worth something. (Side note: I'm very short-term bearish on solar stocks; I'll post about that later too.) On Thursday, I made two bets, on E*Trade and Citi, which both ended up being slightly profitable; however, I passed on the biggest surprise of the week, the company that owns the internet, Google.

I was looking at Google options but ultimately decided it would probably be like throwing money away. After all, the level I was looking at $490 or $500 calls) were $50 out of the money - I thought that they would surely expire worthless, even if the report was good.

I was wrong, and it hurt. The $60 contract of $500 April calls sold for between $2,500 and $4,700 on Friday. Lots of wealth changed hands in the way-out-of-the-money contracts; what was selling for dollars or pennies on Thursday was worth 50-100x as much Friday. However, as a (self-proclaimed) long-term investor, I have to look past such fanciful missed opportunities and focus on the future.

Lots of companies still have to report their quarters over the coming weeks. I will post individual thoughts, analysis, and predictions concerning the coming days, or even specific companies.

What did I promise again? A bearish writeup about solar stocks, individual earnings predictions... I'll also tease and say I'm going to write about the attractive value of PetroChina - keep checking back all week for the frequent updates.

Companies reporting that I'm eyeing up this week:

Monday: BAC, NFLX
Tuesday: MHP, OXPS, YHOO, VMW
Wednesday: UPS, AMZN, AAPL, CMG, NTRI
Thursday: POT, PEP, OXY, COP, MSFT, WDC, DECK
Friday: HMC

I'm expecting good news from some, and bad from others. Let's crank up the guessing machine.
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A Weak Week?

Note: This is published before the markets open for the week of 11/12.

The performance of the major indexes over the past week can be viewed two different ways.

As I have said before, predicting the market is nearly impossible and (overall, for a long term investor) generally fruitless. However, when writing a blog about the stock market, it's necessary and fun.

This past week, the Dow and S&P 500 both shed about 4%, while the NASDAQ endured an 8% haircut. (The majority of these losses came on Thursday and Friday, with some of the indexes and many individual stocks actually posting gains between Monday and Wednesday).

Many of the high-flying tech stocks (that I shorted in my fantasy portfolio; read my previous post) led the market downward.

• Google lost over 10%
• Research in Motion dropped over 20%
• Baidu.com dropped nearly $100 from its all-time high around $430 early in the week to $340 on Friday
• Chipotle Mexican Grill, on which I stated I had a bearish outlook, lost about $20 from $140 to $120
• Even the blue-chip Cisco lost 10% after reporting good (but not spectacular) earnings

Both the S&P 500 and Dow are both within a few percent of their mid-summer lows, with the NASDAQ a little farther away due to a bigger run-up in recent months.

Many professional analysts cite those summer lows as an important level of support. If indexes crash through those lows, look for new, much lower bottoms. But if the markets tap the barrier and bounce back, the bull market may be revitalized.



However, looking at it simply instead of technically, I see reason for weakness to persist in the markets.

Oil, though now off of its highs, is still in the mid-nineties per barrel. Gasoline and other distillate prices are now only starting to catch up to the rise of the price of oil, so watch for consumers to now finally be effected by $90+ oil.

The dollar is crashing. Though such terms haven't been used yet, and though I'm not an international monetary policy specialist, I'm comfortable using that term. After reaching parity with the dollar within just the past month or two, the Canadian dollar now trades around $1.05. When currencies are appreciating faster than markets (with 5% monthly changes of 10+% yearly changes), I think that the depreciation is becoming dire. The dollar is hitting new lows against the Euro on a daily basis. As the Fed continues to weaken the dollar through cutting rates, it's making the problem even worse.

Lastly, the subprime problem is far from resolved. Major banks and investment houses continue to write down their books for losses in securities. Major corporations like Bank of America, AIG, and Morgan Stanley are plummeting in value. Homebuilders, though recently pushed out of the spotlight, may still be in danger of going bankrupt. As the cost of imported goods starts and continues to rise, Americans won't have money to buy houses.

There are just too many logical reasons why the market could continue to go down, while there is little logic for an upside bounce. I own some puts in an ETF that tracks the S&P 500, and when they expire this week, I may buy an Ultrashort ETF. I could easily be proven wrong in the short or long term, as political, economic, corporate, and emotional conditions change, but I see no reason for the markets to immediately rebound in the context of today's environment.

Oil is Bubbling

As I alluded to in my longer posts about oil, I stated that there was some potential for some short-term upside, due to today's inventory report and pending Fed rate-cut decision.

I pointed out that when inventory reports were negative, they were dismissed as irrelevant, but when bullish, they were said to be the most important data ever. That was supported today; a slight decline in inventory popped oil up to a new record high.

Thankfully, I'm still holding my COP calls.

If the Fed cuts this afternoon, oil could go even higher.

It's a matter of momentum vs. fundamentals. As an investor that tries to trade on fundamentals, oil shouldn't be $94. However, just like in a stock like BIDU or CMG, momentum can, and will, push the price higher even when its illogical.

I think I'm going to hang tight in my COP calls position until after the Fed reports. I don't know when to exit... it's so hard to predict when people will realize that this price is ludicrous. Oil may very well hit $100 within a week, but I want to keep reaffirming that in 3 months, I think it'll be closer to $70.

Oil Price: A Real Gusher

I'm actually taking a class on the history of oil right now; it's quite interesting.

But anyway, to the point:

In overnight electronic trading, oil is now putting up new record highs. As of the most recent quite while I'm writing this, it's over $93/barrel, up over $1 from its previous high.

(In the short term, this could be good for me... I currently own some ConocoPhillips calls, and on most otherwise-newsless days, the price of oil stocks will track the price of oil).

However, as I published earlier, I that there is no merit to these inflated prices. Just this weekend, Barrons published their own articles about how the price of oil is looking quite high. There are some tensions in the Middle East right now, but there's really no tangible reason for oil to be setting new daily highs.

One of the dumbest price-triggers of the previous week's run-up was the midweek inventory report that propped up the price 3%.

During the previous weeks, the reports had been bearish, as inventories grew. The bulls that spin the media wrote off the reports as unimportant, when considering the big picture.

Then, the first report that shows a decline in inventory sends the price skyrocking. It's really illogical and dumb.

That's why I'm trying to milk this bubble for all it is worth. I owned some Conoco puts going into earnings, and about $5 of negative price movement nearly tripled my options. As the stock appeared to be bottoming out (I did a good job predicting the bottom, within about $1) I switched to some calls, as the price of oil is now trending upwards.

So, as I said when oil was $10 cheaper, there's really no fundimental reason for oil to be this expensive. If you're an experienced trader/investor, maybe think about playing the swings, like I am. If you're a long term-oriented investor, I'd suggest getting into one of the oil companies with lower P/Es - like Conoco - or just sitting on the sidelines for a while. I truly believe that oil is quite overvalued, but there's no telling if, or when, people will come to their senses.

Barrons recommended avoiding Petrochina; It's P/E is in the 20s, versus about 8-11 for the big American companies. It's tempting to get into a hot, well-performing Chinese stock, but I'd recommend staying on the sidelines, too.

Black Monday 2: October 22, 2007

Note: The chance of this actually happening is minute. This isn't a prediction of what WILL happen, but just speculation over an event that has a tiny chance of occurring.


Investors marked the 20th anniversary of Black Monday on Friday by selling off each of the major exchanges by 2-3%. Bad earnings may have initially triggered the downturn, but it seemed as though investors simply wanted to mark the anniversary with a decline.

However, as the official anniversary passes, I think that the conditions now are the most reminiscent of 1987. If there was or is a time to speculate about a crash, that time is this weekend.

Here's why:

During the week preceeding the crash, the Dow lost about 10% of its value. This past week was not nearly as bad, as the market lost a little less than 5%, or about 600 points. Though not as severe as a drop, it still bears a very eerie resemblance to what happened then. Here's a chart of the Dow over the past week:

Not a pretty chart.

As it's been stated in every other writeup about a potential 2007 crash, the general market conditions are similar; high oil, weakening dollar, and more.


So, why do I think that there's a slight chance of a crash (or correction) in the future?

First, the emotional aspect to this coming Monday. As I am writing this post, a front-page article on MarketWatch.com compares this past week to the week proceeding the crash. As analytical articles of 1987 state "investors had a weekend to ponder losses from the week before," now, today's investors are pondering this week's losses in light of 1987. There's certainly possibility of an irrational, emotionally-driven over reaction on Monday.

The other thing that increases the possibility of a crash, and concerns me, is the high valuations of certain stocks and industries. It's true that the overall market valuation today is less than it was in 1987, with P/Es then higher than they are today.

However, certain sections of the markets have rich valuations: popular tech companies like Apple, Google, VMWare, Amazon.com, and Research in Motion all trade at 30-80 forward P/Es. A 10-20% shaving off of the top of any of those stocks would not be uncalled for.

If Apple or Google were to lose 15% of its value, it could easily trigger a ripple-effect sell off through the broader market. Those tech heroes both represent the current bull market and actually hold lots of investors assets, many of whom may have purchased recently as companies are making new all-time highs. Investors may sell off early to minimize losses, and this effect could be worsened by stop-limit orders that some investors have in place.

Lots of Chinese companies are similarly situated; speculation over the high-growth stocks has created rich valuations, and as the recent 50+% decline in some solar stocks shows, losing a significant amount of value in a very short period of time could occur.


This hypothetical crash would probably begin the same way that 1987's Black Monday did: US investors wake up to news of major, but not crash-level, sell offs in Asian and European markets, in response to US losses on Friday and their own sky-high valuations. (With India's market losing 10% of its value in one day just a week ago, and with Shanghai doing the same earlier this year, a 10% decline on any Asian market isn't too unrealistic).

American investors, shaken by the 5% drop last week and the 5-10% Asian drop overnight, coupled with the emotional fear of a repeat of Black Monday, start selling as soon as the premarket opens. Baidu falls $100, or 33%. Google loses 15%. Apple (who releases earning after the bell, which everyone now forgets about) is down 15% too. Banks, who reported bad earnings this past week, would mirror this fall due to financial fears. Investment banks, with lots of money tied up in mortgages and tech stocks, would also begin to suffer.

A wave of selling has spread throughout the entire market by noon. The tech-heavy, high-PE Nasdaq loses 15%. The Dow and S&P don't fare as poorly, but both are down about 10% too. Things could get very, very ugly.




Now that my scenario is outlined, do I believe that this WILL happen? No. If I did, 70% of my money wouldn't currently be long in equities. I do own puts in ConocoPhillips and the SPDR ETF, so I have slightly insulated my positions against a big loss. But if I thought a crash was inevitable, I'd be 100% cash, or puts, or shorted stock.

The possibility of a 1% gain tomorrow is much, much bigger than the prospect of a 10% loss, but I just figured I'd chronicle my thoughts as every investor is nervously awaiting Monday. Do I want a crash to happen? Absolutely not. But, as my position in SPDR puts suggests, I do expect a correction in the reasonable future, and wouldn't be absolutely shocked with a more sudden drop.

Cramer's hype and two lessons on 10/11

I am not a fan of Jim Cramer's mad money show. I have to credit him for being a great investor during his hedge fund days, but he has been reduced to a cheerleader on his television show.

Take, for example, what he said on his show just yesterday. Here is a direct excerpt from the TheStreet.com writeup about the October 10th show:


"At this point you have a duty to yourself and a duty to your wealth," Cramer said, "never to take financial advice from anyone who doesn't recommend Google." Analysts that knock Google can only be so wrong about a stock for so long before admitting they're wrong, he said, and it's time for investors to stop paying attention to the bears.

Cramer said his price target for Google has always been lower than where he actually thinks it's going to go.

Cramer then raised his price target to $750. "This is a total and unequivocal lowball estimate," Cramer said.

This estimate might seem overly exuberant, but Cramer believes it's based on genuine arithmetic. If Google earns $20 a share next year and continues its trend of 30% growth, it should hit $750. He then said that a nonconservative but rational price estimate would be $900.

It's truly irresponsible and unprofessional for a man of Cramer's reputation to pump up a stock like that. Calling analysts that do not recommend Google sissies or idiots is disrespectful and uncalled for.

Let's see how well Cramer's "four horsemen" did today:

Google, -.5%
Research in Motion, -8%
Apple, -3%
Amazon.com. -6%.

Those numbers don't necessarily show how bad a Cramer-follower could have done; all but Amazon rebounded from intraday lows. At one point:

Google traded at prices as low as $609, after an intraday high of over $640. An ameture trader could have really gotten burnt.
Research in motion spent much of the last two hours of the day down over 10%.
Apple also fell almost 10% before recovering some ground.

It's also worth mentioning that Baidu.com, another stock Cramer pumps, lost over 10% of its value today.

My point is that Cramer's constant pumping reminiscent of the market sentiment in 1999 will only hurt his beloved viewers. As his four horsement hit daily highs, Cramer hit "Buy, Buy, Buy." If these stocks correct to appropriate levels, average, ignorant investors that fell victim to Cramer's antics will be left holding the bag.

So my two lessons:

Don't by into hype; do your own independent research. Are Google and Apple good companies? In my opinion, yes. Are they good investment ideas right now? Maybe not.

Secondly,
Don't be as yellow-bellied as I am; have a little courage.

I bought an Apple October 160 put contract for $1.60 on Octover 9th, looking for a pullback that I believe is due. I sold them early today for no gain, because I was worried about a continued rally.

The options closed at $3.60 today, after a few trades above $6. If i had followed my CORRECT investment instincts, I would have made out handsomely while the market got punished. However, I bought into the hype myself and it cost me a couple hundred dollars.

And, because I love being kicked while I'm down, I decided to personally add some insult to my injury.

After I sold the Apple puts, I bought Google's October 560 Puts for $.90. I sold them for a modest gain after the stock dipped for $1.20.

Once again, I should have followed my instincts; the options closed at $2.25 today after trading above $3. I would have realized returns of hundreds of percent today if I would have just believed in my ideas.


So enough rambling. My point is, I made to very, very stupid trades, influenced by the sentiment that I was trying to play against - the overhyped, artifically-inflated hysteria that had been sweeping the market.

Just to clarify, Those two trades represented less than 2% of the money that I manage; my equities were actually up today. So, I didn't lose money, but stupid, sheepish trading prevented me from making a couple hundred dollars today.

My message to you is this: be braver than I am. Do your own research, and when you come to factual conclusions and believe in your idea, stick with it.

Don't be influenced by Cramer, any talking head on TV, or even myself. I encourage independent, smart investing.

I'll admit my mistakes, and chock this one up to a powerful, yet unfortunate, learning experience.

Oil Bubble about to Burst

Other than the huge rate cut, what else has been in the investment news every day lately? The answer is the increasing price of oil. Even as the stock market rallied through the end of the week, the price of oil kept rising, hitting a all-time actual dollar (non-inflation-adjusted) high, before losing a little ground in the little of the week.

There's a few things causing this high price; MidEast instability, hurricanes in the Atlantic, and some supply/demand issues in the United States. However, I feel as though oil (and oil stocks) are currently overpriced, and are set to correct as soon as the price of oil does.

Sure, predicting a peak is difficult, but I think that you don't have to be exactly right to profit off of this current oil bubble. As the chart below (of Exxon [XOM]) demonstrates, the stock's price is quite volitile and moves quickly and significantly as the price of oil changes.


Now here's a chart of the price of oil, over approximately the same period:

The correlation is obvious, and consistent. Also, on the chart of the price of oil, you can see how the current price run-up has increased volume, and therefore, speculation.


On Exxon's chart, you can see how as the price of oil declined earlier in the summer, the stock lost about 15% of its value in a rather quick period. That's exactly the decline that I foresee happening soon, and that I aim to profit from.

In the next week, I think the price of oil may stay steady; there's a few areas in the tropics that may turn into storms, which always cause jitters and cause the price of energy to rise. However, summer driving season is now over, and as gasoline prices rise to reflect the current price of oil, people will be further discouraged from driving, decreasing demand.

So, as I feel as though the price of oil is going to flatten and drop (it may already be happening now, as the price was down marginally on Friday the 21st), I'm going to try to initiate a short position in a big oil producer, or just buy some put options. There's lots of companies that I could see this working for: Exxon (XOM), Chevron (CVX), and ConocoPhillips (COP) are some names that come to mind. Also, iShares has an ETF made up of lots of oil companies with the symbol IXC - it may be an option to get into the general market without the risk associated with a specific company.

Overall, I think that the price of oil is going to continue to rise in the long term, until alternative energies become a reality. I'm currently long in Marathon Oil (MRO), because much of their business is refining, not production, and they are less effected by the daily price of oil.

After trying to profit from the short-term downturn, I plan to go long in oil, whether in the ETF (IXC) or an individual company. After correcting in the near term, black gold will shine in the future.