From GE to G7 – What a Week!

What a difference a day makes!

We were right on track and doing great for the week until Friday, when GE rained on our parade.  Right at the end of a lovely 2-week consolidation above 12,500 we had to have a down 256 day that dropped us back to 12,325, sill a nice improvement over March, but certainly not where we wanted to be.

Needless to say, other than our Short-Term Virtual Portfolio, which had very nice gains due to housing our index puts, the other virtual portfolios all took hits but, on the whole, we gave back very little of last week's gains, which were spectacular.  As option sellers, we really don't care about a pre-expiration dip, the question that faces us next week is the classic Shakespearian puzzle "To cover or not cover." That is the question.  Whether it is riskier in our virtual portfolios to brave the depletion of value that may lower our fortune or to take deep covers against a further downturn and, by covering our longs, to cap our gains, to profit no more from a recovery that we still dream of…

The gains of the index puts in the Short-Term Virtual Portfolio took the sting out of the losses on Friday and we were very lucky to get good prices for our Long-Term Virtual Portfolio covers from our timely Thursday review as many of the contracts were slow to drop.  Hopefully we are not OVER-covered into the weekend but it is better safe than sorry I think:

• Short-Term Virtual Portfolio: Up 9% for the week.  Just 11 open calls dwarfed by the value of 8 naked puts and our 1/2 covered DIA puts.
• Long-Term Virtual Portfolio: Down 4% for the week.  14 naked calls, 29 covered positions. 
• Stocks: 2% gain for the week.  4 covered positions, 1 short put (IBM).
• Complex Spreads:  Down 12% for the week, too much naked Google!  Still half naked on Apple and Google, all naked on CROX.  Google earnings are Thursday so this is going to be a crazy week!
• $10,000 Portfoio:  Down 7% for the week.  More naked than last week with 3 open calls – we'll see if that risk pays off next week.
• $25,000 Virtual Portfolio: Down 7% for the week.  4 naked positions, 9 covered positions.
• Day Trading Virtual Portfolio: Dead even.  The truth is we would have done better if we had cashed out last week and started fresh as we put too much effort into protecting ourselves.  If we head down further I'd rather cash out and start from scratch most likely as flexibility is key and the spreads are taking that away from us (even though the protection is working).  I got a little too conservative protecting our ridiculous gains from just one month of trading…

As we expected, we got the G7 making all the right noises and, in fact, the lead line of the WSJ article is: "The world's major economic powers issued a warning to financial markets Friday that they won't sit by and watch the dollar continue to slide against other big currencies."  In a highly unusual move, Treasury Secretary Henry Paulson, Federal Reserve Chairman Ben Bernanke and their counterparts from the Group of Seven nations said in a statement: "Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability."

Their words, though mild at first glance, mark a departure from the communiques the officials issued after previous G-7 meetings and appear intended to demonstrate the group's desire to put a floor under the falling dollar. Currency traders scrutinize the wording of official pronouncements for the tiniest changes in inflection. By those standards, Friday's communique was blunt, even though the group stopped short of using official money to buy up dollars and push the currency upward.

Of course, the declining dollar has been a key contributor to our "liquidity crises" as those who have dollars are unwilling to lend them in a period of rapid decline.  Why is this?  Well I give you $1Bn now to buy a factory (an asset) with and charge you 6% interest over 15 years.  You build your factory and make money and charge for goods and services along with inflation and currency fluctuations but, as the dollar drops in value 25% in two years, you are only paying me back $1.12Bn so far.  If the dollar drops another 25% in the next two years, you will pay me another $120M in interest but your principal, adjusted for my original dollar value, is down 50%. 

We discussed how inflation is good for borrowers in great detail in my "Inflation Nation" article and now we are approaching the end game of the plan Paulson and I put into action back in late 2006, when we set out to reduce the effective national debt by devaluing the dollar.  Now that we have chopped off 20% of the dollars value (25% against the Euro) in just two years, our own lending officers at the G7 are getting a little nervous that the $10Tn they lent us will get a $2.5Tn haircut come payback time.

When lending money becomes a losing game for the banks, they tend to do less of it…  We've been shorting oil stocks on the premise that something would be done about the dollar as this situation cannot be allowed to continue and, finally, the EU, who are now facing their own inflation issues, are saying enough is enough.  We were a little off in our timing – way back on March 28th I called for a "Deux ex Machina" to save our markets and we did expect it to be G7 action as there was little hope the administration was going to voluntarily call an end to the dollar bonfire party they had started.  As I predicted at the time: "THEY are not going to let the dollar fall to 70."

As I said on Monday, when I warned not to buy into the morning rally, it's earnings season and, although GE was a shocker, they were no more so than any other major financial and they joined CHP, SGR, MERX, GBX, RAD, WDFC, ACGY and AA on the week's miss parade, offset by beats by LAYN, MSM, ZZ, CC, ISCA, PGR, APOG, BBBY, FCSX, PIR, JOSB, DNA and FAST – hardly a disaster so far.  Of the firms that did miss, only GE, RAD and MERX issued downside guidance revisions.  As I said back in January, this is a pretty poor excuse for a recession so far!

Monday night I called a $109 top to oil as I said: "Where do energy traders think the next $1Bn a day is coming from?"  We finished the week at $110.14 but we're certainly not ready to throw in the towel yet as our rolling up strategy for the puts has been keeping us in decent position so far without too much damage.  If we don't get a nice drop next week, we may rethink our positions but we went into the weekend with lots of naked oil puts (we had hedged on Monday but those putters are gone now).  Tuesday morning we gutted out Alcoa's miss and I called a bottom on SNE, with the 2010 $40s, which came in at $8.20 on a nice opening dip, now $8.85.

Tuesday, aside from pretty grim Fed minutes, we were also attacked by the Pim(p)co tag team of Greenspan and Gross, who did everything they could to talk down the economy, seizing on the weak language of the Fed minutes that Greenspan, as a former governor, gets in advance of the general public.  By hiring Greenspan, Gross gets to have his spin statements well doctored ahead of the public release making Greeenspan's millions in fees the best money Bill Gross ever spent.

Let's keep in mind that Greenspan's new master, Bill Gross stated flat out on Monday: "What we are seeing is the collapse of the modern day banking system," this is NOT friendly advice from a neutral party folks!

As I said in Tuesday's wrap-up: "What a disaster it will be for the bond pimps if the economy doesn’t collapse and their investors do start looking to put their cash to work on more positive endeavors.  How terrible for Whitney, Gross, Greenspan and others if the banks don’t fall into a black hole and the $60Tn global economy doesn’t collapse over what is, so far, about $400Bn in losses (which are paper write-downs) by a financial sector that pulled in $2Tn in profits last year."

Oil peaked out at $112 on Wednesday morning and I pointed out again how ridiculous it was to keep being bullish on $110 oil and bullish on the global economy as they are very unlikely to coexist but the "Fast Money" logic being promoted by the MSM is the old "flight to safety" arguement for investing in commodities.  Now that the scarcity argument has been blown out of the water by 3Mb per day of OPEC cutbacks and now that the demand argument has been shot down by the latest IEA report (and observation of US demand and inventories), they have moved onto the "commodities as a hedge against dollar devaluation" ploy, 25% late to the game, for the sheep who follow the call of the "experts".  This reminds me of the scene in the Blues Brothers (which I can only find in Italian) in which John Belushi gives Carrie Fisher an increasingly ridiculous list of excuses to keep believing in him, only so he can save his ass and dump her again – sounds familiar in any language!  In the fact of skyrocketing oil prices, King George dropped everything to tell America how urgent it was to support his Free Trade Agreement with Columbia because they're his buddies!

Thursday morning we saw the dollar heading off a cliff and no action by the G7 was starting to worry me (again, I never expected Bush to do a damn thing without being forced).  Still, despite a dire retail report we decided to back JOSB in the morning post and the May $22.50s flew from $2.40 to $4.75 that day, too bad we covered but, after the roll of the caller, the spread is working out OK for us so far.  We tried to stay enthusiastic in the morning but then Bush came on TV and we went negative, which worked out perfectly as his endless war speech once again tanked the markets into the weekend (with the assist from GE on Friday morning).  My Thursday inta-day pick of the QID May $44s for $3.60, which I noted in Thursday's Wrap-Up, were just $4.30 at Friday's open but finished at $5.50 by the day's end.

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As I said, the week was moving along just fine for us until GE reported, and I had my say on that in the morning.  I will say again, thank you Mr. President as Bush got us short on the market at 12,650 so we actually had fun watching the 300-point dip from the sidelines.  Yes our long virtual portfolios took some but nothing we weren't expecting and I think our team is getting really good at handling these little dips like pros – it's very nice to see the trading styles of our members evolving as we begin to see these sell-offs for the opportunities they are, both on the long and short side. 

To that end, I also called for the FXI $143 puts at $2.50 or less before the market opened and they came down all the way to $2.30 ahead of lunch and finished the day at $3.75 – there's nothing like a 63% day trade to take the sting out of a dip is there?  During member chat, we took up some other positions but when the one I pick at 8am works out, you know we're in good shape!

It was indeed a rough week as we found only 51 positions to close (and we try to close winners).  Partially that is because we are waiting for a lot of callers to give up their premiums but the overall cash gain on positions closed was just 18%, our poorest performance all year so next week better be good!