Wednesday Wrap-Up

This morning I said: "Today we will be happy to avoid a triple digit Dow drop."

Well aren't we lucky to finish down just 96.93!

It's funny, I don't feel happy though…  Perhaps I should have aimed higher or perhaps I was right and we WILL be happy.  The mood was very sullen in our member chat today – no one wanted to talk about stocks so we ended up solving the Iran hostage crisis (they'll be home by Easter).  Ben Bernanke had no Easter cheer for Congress as he said "risks to the economy have grown, especially from business investment and housing."

In a very Greenspan-like mastery of Fed doublespeak, Bernanke was able to say that the Fed's outlook hasn't changed but the risk of those outlooks being wrong have drastically changed.  In other words, we're not changing our official stance but the forecast isn't worth the dollars its written on!  "We are looking for a bit more flexibility given the uncertainties that we are facing and the risks that are occurring on both sides of our outlook," Bernanke testified.

Ben also gave little hope for the easing everyone was counting on in last week's "rally" as he said "Our policy is still oriented toward control of inflation which we consider at this time to be the greater risk…  Recent inflation readings have been elevated and the scarcity of skilled workers and accelerating labor costs pose a risk to inflation." 

What I really objected to was this statement: "Although the turmoil in the subprime mortgage market has created severe financial problems for many individuals and families, the implications of these developments for the housing market as a whole are less clear."  Allow me to clear that up for you Ben:

• 10% of all mortgages are sub-prime, affecting about 2M homes.
• Home prices are going down, not up, putting these mortgages "under water."
• 20% of these mortgages are moving to default, and that's with rates under 7%.
  • That's 400,000 homes that will be empty in about a year.
• The 80% that haven't defaulted aren't all doing great, just not bankrupt yet
  • If just 1/4 of those people are forced to sell, that's another 400,000 homes on the market this year
• If doubling the amount of homes available for sale is accompanied by rising rates and tightened lending requirements – where are the new buyers going to come from???

What if the banks and the desperate sellers decide to take a 10% hit on their homes?  What does that do to the value of the other 100M homes?  How are the builders going to sell their 1M new homes with 1.6M unsold used homes on the market?  What about the loss of assets for 800,000 consumers taking a 10% loss on their homes (US average $250K) – that's a $20Bn hit to US consumers.  If my home drops 10% in value how will I get a line of credit to buy more stuff?

I could go on but I'm sure Ben now gets the idea some of the "implications" for the market as a whole.  Unfortunately, I was being very kind and using Ben's numbers as the facts are much worse:

• 33% of new mortgages and home equity loans in '05 were "Interest only"
  • Just because they are technically "prime" doesn't mean people can afford them when they ratchet up
• 43% of first-time homebuyers put NO MONEY DOWN.
• 15% of 2005 buyers (it's worse now) owe at least 10% more than their home is worth.
• $2.7T of loans will adjust higher this year.
  • A 2% rate hike on $2.7T is $54Bn taken out of consumers hands.

The BZH charges indicate that these practices were stepped up in 2006, not pulled back so these numbers may be far worse once we get the final tally for last year.  Sounds pretty bad doesn't it?  Well it's much worse than that…  According to Barry Ritholtz, in 2005 47% of WM's (his example bank) ARM loans were in NEGATIVE AMORTIZATION (payments were not covering the interest charges so the shortfall is added to the principal).  It's OK though because the bank (and I wish I was joking) BOOKS THE NEGATIVE AMORTIZATION AS EARNINGS.  "In Q1 2005, WaMu booked $25 million of negative amortization as earnings; in the same period for 2006 the number was $203 million."  Wow, on track to do almost $1Bn in "profit" based on their gain in "house value" that is owed to them. 

It would be a shame for them if home prices went down, wouldn't it?  What?  They did?  Oh dear…

Well at least we don't have to worry about inflation further eroding the value of our assets do we Ben?  "Another significant factor influencing medium-term trends in inflation is the public's expectations of inflation. These expectations have an important bearing on whether transitory influences on prices, such as changes in energy costs, become embedded in wage and price decisions and so leave a lasting imprint on the rate of inflation…  a less benign possibility is that tight product markets might allow firms to pass some or all of their higher labor costs through to prices. In this case, increases in nominal compensation would not translate into increased purchasing power for workers but would add to inflation pressures."

Anyone want to buy a house?  I'm thinking it might be time to sell…

See, I told you we would be happy to avoid a triple digit Dow drop (it doesn't count that we fell 200 points in 3 days does it?).  On the whole, our indices held up fairly well with the SOX giving us the biggest scare and the Nasdaq taking the biggest major index loss:

 It's not a party but it's not a panic either – yet! 

Not panicking was our plan for the day in the "Iran Silver Anniversary Hostage Crisis" and, as I said in the morning: "Believe it or not, I will still be looking to pick up some puts around the inventory."  We executed on our game plan to take the TSO and VLO puts as we caught onto the scam right at the open when I said:  "Look at the oil patch sell into this oil run! What a massive load of BS this all is."

That didn't stop us from making a bullish (as you can't have BS without bulls!) play by selling the VLO $65 puts for $1.44 against our existing (and badly damaged) $55 puts and we ended up recovering .15 on that trade, which we will use to reduce the basis of the $55s.  By 10:10 I said: "Man I love TSO – back to $100 and just begging to be shorted!"  Zman gave us the report at 10:31 "all below expectations." and within 2 minutes we jumped on TSO $95 puts for $1.90 (now 2.30) and XOM $75 puts for $1 (now $1.10), adding: "Oops, drawdown is VERY disappointing!!! Totally out of oil calls."  The VLO $65 puts were a huge win as we turned and bought them and they shot up from $1.30 to $2.15, were we got half out.

Of course we took some covers to fend off the overnight madness and, so far, there have been no market-moving rumors today but, as I said in the morning: "Was the "rumor" timed to allow oil traders to bail ahead of a very bearish inventory report?  We’ll be watching the trading action very closely today but I still maintain that gold is NOT indicating a crisis below $680, especially with the dollar in the toilet."

Yesterday's rumors came pretty much EXACTLY as trading was closing, insuring the maximum impact for the minimum money.  "The migration of global energy contracts to the electronic arena from exchange trading floors makes it nearly impossible to identify the source of the original buying, and the Nymex says all trades executed during those frenetic minutes have been verified."  How convenient – they can verify the orders but not who placed them!

The rise in oil triggered preset buy orders and seven minutes later, at 4:52 p.m. prices began to rocket, soaring within seconds from $64.43 to $68.09 a barrel.  Volume soared during those minutes, although it thinned out the closer prices got to $68. Only 16 contracts, representing 16,000 barrels, were traded between $68 and $68.09, according to Alaron Trading Corp. in Chicago.  "It was an explosion," said David Beaver, a broker at the brokerage firm. "The Persian Gulf didn't blow up, prices did."

16 contracts…  That's all it takes to alter the charts, that's all it takes to get a headline that CNBC ran with for an entire day, even though the entire matter was an obvious attempt to force prices higher.  Amazingly, the masterminds at CNBC (Criminal Narrators Boosting Crude) couldn't focus on the news of the false rumor spiking the NYMEX, proving how dangerous and unreliable this vital trading system is – instead they focused their day on the "Iran Crisis" and the draw in crude. 

Trading volume on the NYMEX was, in fact, lower than normal today and the total barrels on order for May-July is 607Mb, up a grand total of 10M (I kid you not) since last Thursday's close.  Magically, those 10M barrels (1.7%) have caused the price of crude to climb 5% in 4 trading sessions.  As is usual with NYMEX shenanigans, only the front month contracts are manipulated to rape the American consumer, longer contracts traded down as much as .55 (Dec 2012) for the day.

Gold went nowhere on the day, hovering appropriately at $666 while the dollar actually held 83 after testing 82.75 as it became evident that the Fed is NOT going to be easing rates any time soon.

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The S&P (and others) opened below our danger zone this morning and triggered our mattress plays, which saved us a lot of grief:

• DIA Apr $123 puts opened at $1.15 and stopped us 1/2 out at $1.60 (up 39%)
  • That money was used to buy Apr $122 puts for $1.05
• QQQQ Apr $44 puts opened at .75 and never triggered us out (now .90).
• IWM Apr $79 puts came in at $1.35 and stopped 1/2 out at $1.55 (up 15%)
  • That money was used to buy Apr $78 puts for $1
• SPY Apr $142 puts opened at $1.55 and we stopped out at $2 (up 29%)
• SPY Apr $141 puts were picked up at $1.25 and stopped out at $1.75 (up 40%)
• SPY Apr $140 puts are still open, even at $1.20.

Hopefully we won't need to do another round tomorrow and, of course, we need to stop out of our remaining calls no worse than even as that should signal a recovery.

We got stopped out of a few calls and took some oils off the table but, on the whole, we're pretty well balanced to go either way tomorrow: