Just Another Manic Monday

Wow we had a busy weekend!

I wrote about 6 pages of comments this weekend, doing an overview of the economic situation at the end of Friday's post (we decided we like F at $1.58) and in the comments of the Weekend Wrap-Up, there is a books worth of strategy advice as we look at Edro's virtual portfolio along with new plays on OSX and DRYS.  I would have to call this mandatory reading for members!  The discussion centers around our "buy/write" strategy outlined in "How to Buy Stocks for a 15-20% Discount" and the most important point I made was:

Keep that in mind when you are successful in the position.  You are NOT locked into the amount of shares you have.  If you are not comfortable with an assignment number, you can always cut your entry back by half or more so the assignment only has the net effect of putting you back to the same amount of shares at a lower basis.  Obviously, again, again, again I say – If you don’t WANT to own the stock – you shouldn’t be doing this in the first place!  If you want to gamble on YRCW going up but have no intention of owning them, you can take net .60 and buy the Jan $2.50 callls and sell the Jan $5 calls, which makes a 300% profit if called away so rather than risk $4,100 on this position hoping for a double, you can buy 20 of the bull call spreads for $1,200 and make a $3,800 profit if called away and use the other $2,900 to diversify the risk as well as take some downside plays to smoothe out the virtual portfolio volatility.

This is what we teach at PSW – There is ALWAYS an option – No matter what the strategy, no matter what the time frame – you just need to learn to look at the possibilities.  If someone is buying 1,000 YRCW with a 20% stop at $4 hoping to make a 25% profit when they hit $5, why not just buy 10 Jan $2.50 calls for $1.40 and sell 10 Jan $5 calls for 0.80, which costs net $600, rather than $4,000 and returns $2,500 at $5, a $1,900 profit on $600 rather than $1,000 on $4,000 and you CAN'T POSSIBLY LOSE MORE THAN $600.  This is what people do not understand about options – they are meant to be risk management tools, not risk instruments!  Another nice thing about this strategy is that if YRCW flatlines at $4 through January, you still get $1,500 back.  If YRCW falls to $3, you still get $500 back so you are protected from a 25% drop in the stock the minute you enter the play – that is the kind of strategy you need to have for playing these volatile markets.

Also from the weekend, if you haven't seen the video "The Crisis of Credit Visualized" please do and please send it to anyone you think it might help understand this mess (like Congress).  Last week we were driven relentlessly lower by rumors of bank nationalization and this weekend we find that C is in talks with the US about the government taking a 25-40% stake in the bank – not quite nationalized but I think we should at least get a couple of board seats…  Meanwhile, over in Europe, ECB President Trichet decided today would be a good day to kill the rally by saying: "The financial system of the euro area, like those of other industrialized economies around the globe, is under severe strain.  The financial system is hampering economic recovery and, at the same time, the recession is putting greater strain on the financial system."   This neatly reversed a 2.5% rally in Europe, knocking the FTSE down 100 points in a straight line along with the DAX and the CAC, which now begs the question: "Why are the Central Bankers trying to destroy the financial markets?" 

Surely they can't be unaware of the effect of their statements.  Yet day after day, we hear from Trichet, Bernanke and their counterparts in Japan, China, India and around the world the most unsettling things – things that cause investors to have no confidence whatsoever. "In recent weeks we have seen the first signs of falling credit flows," Mr. Trichet said. "An important part of this fall is demand-driven. However…there are indications that falling credit flows reflect also supply-side factors and tight financing conditions associated with a phenomenon of deleveraging.  If such a behavior became widespread across the banking system, it would undermine the raison d'etre of the system as a whole." 

So happy Monday to you!  On top of that we will be treated to 2 days of Berrnanke testifying before Congress in what used to be called a Humphrey Hawkins Testimony under Greenspan but I think after a couple of Ben's embarrassing, almost tearful presentations the Hawkins estate must have pulled the naming rights.  Actually the purpose of the testimony USED TO BE to report on the target ranges for the money supply as mandated by the Humphrey Hawkins Full Employment and Balanced Growth Act of 1978.  That legislation expired in 2000 and since then, the Fed has had out of control ability to print money like mad and they flooded our nation with easy credit (again, the video does a great job of illustrating this), inflating the price of everything, and doubling our national debt until the whole bubble collapsed and destroyed the universe.  Happy Monday indeed!

It's going to be a busy and scary data week:  We have the Case/Shiller Home Price Index for December tomorrow, which may show almost a 20% drop in home prices from last year.  We also have Consumer Confidence at 10, which was at 37.7 last month (down from 140 in Oct 2007) along with the Bernanke-thon that starts at 10.  Wednesday we have Existing Home Sales (if any) and Crude Inventories.  Thursday we ge hit with Durable Goods Orders for Jan and the usual Jobless Claims disaster and then New Home Sales (if any) which are looking like about 320,000, down from 1.4M in '05 as prices have fallen 25% over that time.  Friday we get the Preliminary Q4 GDP, probably down about 0.1% and the Chicago PMI just after the bell along with Michigan Consumer Sentiment for Feb, which is very unlikely to be good.  I guess you can call this a "wall of worry" and we'll see how high we can climb this one before slipping back.

The WSJ is, as usual, not helping with the headline: "Sock Market Pullback Isn't Just Financial Now," perhaps they are a little late to notice but they are hammering the point home with statements like: "What started as a subprime mortgage crisis became a U.S. credit crisis, then a U.S. recession, and now we are in a full-fledged, globally synchronous recession of historic proportions," says Leo Grohowski, chief investment officer BNY Mellon Wealth Management in New York."  They have this really cool chart illustrating how much damage just 5 companies can do to the Dow (there's a reason we've been using it as our primary short play) and there is also a front-page article this morning which paints a dire picture for the Newspaper Industry.  Wasn't there a James Bond movie where the multi-Billionaire publisher of a respected financial journal purposely started a war and destroyed the world economy just so he could buy out his competitors cheaply and control the global media?  I wonder if Rupert Murdoch has one of those hairless cats too?

Hillary left China in a very good mood as the Hang Seng jumped 3.5% today, bursting back over the 13,000 mark.  We could not possibly have timed last weeks flip to FXI calls better!  The Shanghai added 2.7% and the Nikkei was off half a point.  The 10-member Association of Southeast Asian Nations enlarged their reserve pool of common reserves from $80Bn to $120Bn "to protect regional currencies battered by the global financial crisis."  The agreement aims to ensure that countries have access to adequate financial resources to relieve selling pressure on their currencies.  In the past year, the Thai baht has fallen 11.8% against the dollar, the Indonesian rupiah has fallen 23% and South Korea's won has fallen 37%. Weak currencies raise the price of imports and make it more difficult to repay foreign-currency debts. China, Japan and South Korea are footing most of the bill to expand the so-called Chiang Mai initiative, providing 80% of the $40 billion in extra funding.

Over in Europe, the EU is moving towards coordinated action with the IMF to bail out Eastern Europe while the UK plans to partially nationalize Northern Rock (remember them?) in order to increase the supply of mortgage loans in Britain.  Foreclosures in the UK are up 54% from last year but "just" 40,000 overall as it is much, MUCH harder for banks to foreclose over there than it is in the states where over 140,000 people PER MONTH are foreclosed on (UK has about 60M people).  This, of course, makes it more attractive for banks to work something out with the borrower.  "In the vast majority of cases where homeowners are committed to working with their lender to keep their home, this outcome is successfully achieved," the Council of Mortgage Lenders said in a statement.  This is something we can do TOMORROW in America – make it less profitable for a bank to foreclose than to work out the modification by simply making it harder to foreclose – good luck getting it passed, of course!  The ECB has many possible policy moves on the table but, with rates still at 2%, their first line of economic defense is still going to be lowering rates and that could push the dollar even higher against the Euro as the ECB heads into their next meeting. 

We'll see where we end up today, hopefully I'll have a chance to post a Big Chart review for members this evening as we check on the global levels.  We were a little bearish going into Friday's close with 1/2 covers on our long DIA puts and I will remind all that the strategy is to roll up the long end first, then add more cover with tight stops on the new half, we're certainly not going to be impressed by anything under 1.25% today (a 20% bounce off last week's drop) and it will take a full 2.5% move higher by Wednesday for us to break the overall downtrend.  We have a lot of rough data to get through and still plenty of earnings so let's continue to be careful out there!