What a rotten day that was!

We only made a couple of plays today as we stood back and watched the carnage.  At 9:27 I targeted FRE in the DTP at $2.60 and we hit it right on the nose at the open, with PSW members setting a bottom in the morning dip.  FRE shot up all the way to $3.50 (up 34%) but we got nervous and bailed at $3.05 with a still respectable 17% gain.  That gain in FRE sent our Stocks Portfolio roaring back as our double down paid off and we are left with our very nice, original spread.

At 10:54 I reminded members we were protecting our long positions with the DIA Oct $117 and $116 puts as the market was failing our levels, that was very timely as they gained 25% and 18% respectively just an hour later and up 30% and 50% since we first added them as covers.  Having index puts allowed us to ride out today’s dip without feeling the pressure to slap covers on as the stocks hit what we hope are the lows for the week. 

We grabbed more WM at $3.65 for the Stocks Portfolio, replacing our successful FRE and FNM gambles but, other than rolling GOOG down to the $490 calls, we had little appetite for taking on more risk as the markets were just simply depressing in their relentless decline.  I noted it was interesting to go back and look over this same week last year as the similarities are striking: "I’m just rereading last year’s week before labor day, we had a bad Monday and then a huge Tuesday sell-off and then the GDP saved us into the holiday (but the week after sucked and THEN we had a 1,000-point rally).  We were at Dow 13,600 at the time, NYSE 9,800, RUT 800, SOX 500 and S&P 1,480.  I was very down on the financials that Tuesday, saying there were many more losses to come than they let on!  Great take on that week’s Fed minutes if I do say so myself.  It was a huge manipulated week starring - the Financials!"

Speaking of manipulation, Cramer went on the attack again, demanding that FRE and FNM be taken over immediately despite the fact that both companies deny that they need assistance.  This does not matter according to Cramer as his pals at GS have already bought up all their debt at a discount and now demand a government backed bailout that screws the shareholders and makes them Billions at the taxpayers expense.  Cramer was on TV last week insinuating something terrible was going on with FRE and FNM and suggesting the SEC should stop the stock from trading.  Seven days later, there was no terrible news and there was nothing that should have caused trading to stop so Cramer has moved on and started calling for a shutdown of the companies he couldn’t bankrupt by panicking investors.   

Now Cramer it threatening financial armageddon if his demands aren’t met.  He told fellow GS alumni Paulson to "take over Fannie and Freddie" and, amazingly, our Republican pals agree that the best thing to do is suddenly to let the government take over a $5Tn business.  I actually sat through Kudlow today trying to figure out the justification for this one but it seems big government is just the ticket as long as you are using their cash to backstop the risky debt you took on before engineering a crisis to force the bailout - just another example of your tax dollars at work for Goldman Sachs.

All in all, it was a rotten day but the volume was low, oil stayed down and that sector crashed as well with XOM and CVX leading the damage in the Dow AND the S&P.  That makes up one half of a rotation play - now we just need something else to perk up so we have something to play with.  The VIX perked right up to 21, a level it hit on Aug 13th and 20th, both days followed by bounces but 22 has been the reliable top of the range since Aug 5th, when the VIX fell from 23 back to 20 and gave us a 350-point gain, starting our best week of the month so we’ll be watching that very closely tomorrow.

We’ll also be watching our Big Chart levels and hopefully we won’t need the bottoms:

We lost the 50 dma on the Dow, fell into 20% horror levels on the transports (despite oil’s decline), dropped 2 greens on the S&P, added a red to they NYSE and the Nasdaq but the 50 dma fell so far down that the SOX is now touching it and the Russell fell 34 points but is still hanging onto market leadership.

Asia is the same disaster it was last week and there were no changes in Europe so this failure is all on us as our markets again lost ground to the rest of the world, as I mentioned in the morning post.  We’ll have to keep a close eye on the 20% line for the Dow and the S&P and, as for the others - there’s a reason we called that 25% line "terror" as that was the line Asia crossed on the way to 50% losses - we don’t even want to go there!

Today’s tickers: LEH, JAVA, DELL, INTC, SCHW, AKAM, KG, APO, TGT, ORCL, KO

LEH - Shares in Lehman Brothers bounded sharply out of the gate today, closing 4.6% higher at $14.35 on speculation of a possible takeover by Korea Development Bank. The move in Lehman comes a day after respected analyst Richard Bove floated the notion of Lehman’s vulnerability to a hostile takeover bid given the dissonance between management and the market’s view of the company’s value, and amid generally bullish action in financials today on back of interest rate-dovish and largely reactive, rather than proactive, rhetoric from Fed chairman Ben Bernanke speaking in Jackson Hole. Response from option traders has been interesting, not least in the October contract, where one fund a trader appears to have played against the “easy-fix” rumors by buying a long 8870-lot put spread between strikes 2.50 and 5.00. This trade was entered for a 25-cent debit, creating an initial break even of $4.75 – requiring an almost disastrous $10 drop. The trader stands to gain as much as $2.25 – 9 times the money at risk – if Lehman shares make a cataclysmic drop, but don’t break below the $2.50 level. Given that options are pricing in only about a 3% chance of Lehman shares dropping below $5 by October 17 – and virtually no chance of a bust of $2.50 – it’s clear that this trader is playing this 25-cent position as a cheap, long shot.

In another October play, traders may have sold 27-strike calls at 22 cents apiece in order to fund a long collar between strikes 12.50 and 20 – a protective play on an underlying stock position that would otherwise cost 33 cents to put on. In this case the trader would have bought the put at the 12.50 strike and sold the call at 20, with that short call declaring a limit to any upside in which this trader can participate. This too would seem to suggest a very muted outlook for Lehman shares, even if a bid is forthcoming.

JAVA - Elsewhere, we observed a few large-scale call-side trades in tech stocks. Options activity in Sun Microsystems caught our attention as shares closed .60% higher at $10.00, as a trader bought a 11,000-lot long call position at the January 12.50 line for 53 cents. About an hour later, a trader sold a 10,000-lot position in 12.50 puts for $2.90. Both of these strategies may be interpreted as bullish on the underlying share price – Sun shares not having traded at this level since June.

DELL - We observed similar call-side position in Dell, where shares closed .32% higher at $25.29, but have perked up some 38% since bottoming out on April 14. Roughly half today’s active volume in Dell options is centered in January 30 calls, where 10,000 lots traded to the middle of the market at 67 cents. Based on the premiums paid, we’re surmising that the calls were bought in a bullish wager on Dell Computers that would put shares back at levels not seen since October 2007.

INTC - Another large-volume long call position was entered today in Intel, whose shares closed 2% higher at $23.49. The trader in this case appears to have bought a 10,000-lot position in January ’09 30.00 calls at 22 cents apiece – this premium reflecting only about a 10% chance of the position landing profitably by mid-January expiration. Intel shares last traded above $30 in 2004, but this protracted pullback has done little to upset the relative overweight of open call positions to puts. Calls current outnumber puts in Intel by a factor of 1.3, and this proportion has remained stable for many, many months.

SCHW - Rumors of a Deutsche Bank bid for Charles Schwab appear to be fueling speculative options activity in the brokerage this morning as shares closed 3% higher at $23.73. The rumors pumped implied volatility 19.3% higher to 47.8% as options traded at nearly 14times the normal volume. With calls outtrading puts by more than 8 to 1, traders bought calls into bullish momentum, particularly at the September 25 line, with interest spilling over into this strike price in the October contract. At least one trader opted to take the other side of the bet, buying a 1,500-lot long position in September 25 puts for $1.85 per contract.

AKAM - Takeover chatter, albeit of a more diffuse nature, is also coloring the volume in options of Internet content delivery company Akamai Technologies, whose shares closed 4.8% higher at $23.67. Options volume has tripled against the daily average, with calls outmoving puts by more than 17 to 1. Buying interest has settled on front month calls at strikes 25 and 30, with volume at these same call strikes in the October contract trading to buyers and sellers. Implied volatility on all Akamai options is up more than 20% on the session at 54.1%.

KG - Shares in King Pharmaceuticals rose 8.5% to $12.19 today after disclosing that it had made a $1.4 billion bid to acquire Alpharma which the company rejected. Option volume in King Pharmaceuticals tripled on the news, due largely to a spell of fresh buying in January 12.50 calls at $1.30 per contract. The premium on this position at $1.30 requires upside to $13.80 to break even, a level that would put King shares within $2 of its 52-week high set back in August 2007. King shares have hobbled this month since losing 17% in a single session after reporting a decline in Q2 profits of more than a third.

ALO - Meanwhile, Alpharma’s finding out that it’s good to be the….object of King’s affections. Shares rose more than 42% to $34.20 on the news – a premium to the $33-per-share bid that Alpharma nixed. The news has lit a fire under Alpharma calls, which are outpacing puts by nearly 3-to-1. Heaviest volume appears at the September 35 calls, which are trading mostly to the middle of the market, while calls at the 40 strike appear to have mostly sold. Activity at the December 35 line showed calls trade to the middle of the market at $2.10, while a trader on the put side roughly half an hour later appeared confident enough to sell 35-strike puts for $1.80 per strike.

TGT - Shares in quirky retailer Target are up 3% at $52.64, three days after reporting a decline in Q2 profits that still exceeded consensus street estimates. Profits were hurt by a consumer pullback in nonessential items, where Target has tended to excel. Slowing profits or none, it’s been a banner month for the retailer – its stock is up more than 17% this month alone. One trader looks to have positioned for stocks to remain above the $50 watermark into September expiration while taking in premium by selling a 3,500 put spread in the September contract between strikes 47.0 and 50. The trader took a 65 cent credit that represents the maximum potential profit to be yielded if both contracts expire worthless on September 19.

ORCL - A similar strategy was employed in options of Oracle, where a 3,000-lot spread using puts was deployed in the front month contract between strikes 22.50 and 24 as shares printed a 1.8% rise to $22.70. The spread involved here totaled 90 cents, which a bullish seller of the spread would take as a credit in hopes of seeing Oracle shares break their 52-week high of $23.62 by September 19. A buyer of the put spread would take a soberer angle, paying the 90-cents as a debit while betting on a widening of the spread between the two strikes that would result in both contracts being exercised. Bear in mind that the maximum profit for a long buyer of this put spread is just 60 cents – less than the money at risk in the form of the 90 cents paid for the position. In this case, both sides of the spread are reported at the middle of the market, so we cannot confirm whether this trade was entered by a buyer or a seller. Open interest shows existing call and put positions at a near-even split.

KO - Shares in Warren Buffett favorite Coca-Cola are up 1.6% to $54.37, pacing gains in the Dow today. Murmurings of a global slowdown in recent sessions have sparked some market investors to call for positioning away from large-multinationals with heavy European exposure , and option activity over the past week has shown some signs of traders positioning more defensively in December/January contracts in some multinational tickers. It’s in this light that the action in Coca-Cola is interesting, as it appears that a trader entered a 7,000-lot calendar put spread, selling 50-strike puts in the January 2010 $4.00 and buying the same position in the January ’09 contract for $1.60. Along with a $2.40 initial credit, the trader gets some defensive cover against a 7% pullback between now and mid-January.

Bespoke put up an interesting chart today.

It’s a study of total returns by country since March of 2003, when the MSCI World Index bottomed out at 550.  That index doubled up to more than 1,100 last summer and has since fallen back about a third, so far making a neat retracement of the recent gains IF it can consolidate along this line. 

Last week I said I think we have an investable bottom over in China and it’s interesting to note that China’s total returns since March ‘03 have now collapsed to one of the worst levels of the countries measured - all the way down to 79.43% and STILL 2.41% BETTER than the total returns from the US market.  Only Japan has a worse return than the US over the past 5.5 years with a 68.66% vs. our 77.02%.  Brazil is the top gainer with a 427% return, India 2nd at 409%, our neighbors in Mexico returned 408% while our other neighbors in Canada made 142% so you can’t say we’re in a bad neighborhood can you? 

Are we too big?  Well Germany returned 187% over that time and Hong Kong pulled in 180%, and that’s AFTER the big pullback they’ve had this year.  Russia is rolling more than tanks as their market has returned 274% and even South Africa has been killing us with a 308% return.  Is it time for some global rotation to US equities or have our disastrous economic policies put us in the permanent back seat of the global economy?   This is not our Political Post of the Week so I’ll leave it at that…

So the whole World has been having a party to which we were not invited.  Barron’s had a cover this weekend and called it "required reading before you vote" and indicates that Obama’s proposed policy would be a disaster for our economy, urging readers to vote McCain and stay the course.  That course, according to the Bespoke study, has placed the US second to last in global growth and we are losing ground to Japan even as we speak.  We can expect this election to hinge on economic issues, which 66% of the voters say is their main concern and we can expect the markets to move up and down with the polls - it’s going to be a rough campaign season so strap in for some fun!

Hong Kong had a party this morning with a 712% gain (3.5% on the button) and the Nikkei was feeling chipper with a 212-point run, still under 13,000 but a nice 1.7% on the day.  The Shanghai Composite was dead flat as the Olympics wound down and it was banks that led the Asian rally while falling oil prices boosted most industry (steel remained down in the dumps though).  Continued strong dollar led to a 4% jump in HMC and SNE and Sumitom Mitsui Financial added 4.24%, which is a pretty strong statement for the group that is looking to buy LEH, indicating the markets are really seeing a bargain in our beaten-down financials.

We talked about the EU economy in the weekend post and London is closed today for a holiday so volume is think and flat today.  Oil stocks are the leading decliners as crude hovers right around $115 in European trading.  Russia is still in Georgia and France is calling for a summit while Russia’s Parliament is calling for President Medvedev to officially recognize the separatist provinces (since 1990) of South Ossetia and Abkhazia. "Today we must fulfill what is I think our historic mission — to defend small countries from aggressors," Federation Council member Boris Spiegel told Associated Press Television before the vote.

Now that the facts are in, the WSJ has changed their tune, characterizing the action as such: "After Georgia tried to retake South Ossetia by force Aug. 7, Russian troops overwhelmed the Georgians, and for nearly two weeks occupied positions deep within Georgia. Most of those forces withdrew Friday, although some Russia troops continue to operate near the Black Sea port of Poti and in Georgia outside the boundaries of the breakaway regions."  This is strikingly different than the Russian agression we heard about for the past two weeks…  Nonetheless, Bush sent humanitarian aid to Batumi - IN A DESTROYER!

"The population of Georgia will feel more safe from today from the Russian aggression," Georgian Defense Minister David Kezerashvili said on the aft missile deck of the USS McFaul after greeting U.S. Navy officers on shore.  "They will feel safe not because the destroyer is here but because they will feel they are not alone facing the Russian aggression," he added.

So tensions are still high and we can expect the oil bulls to continue to lean on the situation to excuse support above the critical $110 line.  Last week’s action demonstrated that the market has virtually no tolerance for higher oil prices so we will be placing our bets accordingly.  None of this is bullish for the global economy as tensions are exacerbating EU stagflation, which is now damaging the mining industry as runaway costs are eating into record revenues, similar to what’s going on in the oil industry which will really begin to hurt if oil drops below $100 a barrel. 

Our pre-markets are not looking good ahead of the Existing Home Sales report at 10am.  Oil is up over $115 despite a strong dollar and that’s not helping but the pre-market sell-off (8:45) seems a bit much since nothing bad actually happened this weekend.  PDS is buying GW for $2Bn, about 1/2 cash and 1/2 stock and a very nice premium over GW’s Friday close at $8.59 although PDS is flying down pre-market and GW shareholders needs to recognize $20.95 a share on the stock portion of the transaction.  There is a limited all cash option.  This is boosting the E&P sector as well as oil but it shouldn’t - it’s been in the pipeline for a while and is more of a merger than a purchase. 

LEH is giving back all of Friday’s gains as a Korean regulator urged caution regarding Korea Development Bank’s interest in that company.  Russian steelmaker Severstal is buying America’s PBS Coal for $1.3Bn, another indication of our administrations "talk strongly but carry no stick" approach to dealing with Russia.  Since Severstal is going to be using the coal for their own manufacturing and not witholding it to drive up commodity prices, the company plans to double PBS production in the short to medium term…

Generally we ignore action on Mondays and this whole, pre-holiday week is going to be highly suspect so we’ll concentrate on oil, the dollar, gold and copper while we see what levels hold up (or don’t) in what promises to be a thinly traded week.

Was that the bottom?

After many disappointments this week actually ended about flat.  We continue to have an inverse relationship between the markets and oil that we discussed last weekend and I gave a play by play instruction book Wednesday on how to manipulate the markets to make Billions using just $50M on the NYMEX that it looks like someone took to heart on Thursday and Friday as oil went up and down 5%, yanking the markets up and down 2% in the process.

Monday was manic as usual, with very nice pre-market gains quickly turning sour.  We fell from 11,665 on Monday morning all the way back to 11,300 on Wednesday and finished the week at 11,628 - not exactly inspiring overall but we held our Aug 4th lows, which were better than our July 28th lows, which were better than our July 15th lows so it’s kind of like progress only without the higher highs that indicate a proper recovery.  So it looks as though we may still be consolidating, and that means perhaps another trip to 11,800 and the next time back down we’ll be hoping to hold 11,450 as a firm bottom to call it progress.

It’s all going to depend on the first two days of this week, if we can race up to 11,800, we have a good chance of breaking up, if we can’t get there until Wednesday, we can expect it to be "hump day" and back down we go.  From a data perspective we have July Existing Home Sales, probably not exciting, on Monday, followed by Consumer Confidence, July New Home Sales (blah) and the FOMC minutes on Tuesday.  Nothing there that sounds like we’ll be making new highs is there?

Our best chance for a big rally is Wednesday’s GDP, which may be even higher than the 2.7% projected (thanks to the stimulus checks).  It’s very, very, very hard to sell a recession story when the economy is growing at 3%.  If we can couple a better than 2.8% GDP with less than 400,000 jobless claims on Thursday morning AND we’re holding 11,800 from Tuesday THEN we may get back over 12,000, that’s the best-case scenario for the week.

We get earnings from TMA on Monday evening and Tuesday we see AEO, BIG, CHS, SFD, TUES, BGP and JCG, which will give us a good look at consumer spending patterns.  Wednesday it’s DLTR, FTD, SOLF, TLB, BNHN, JAS, MW and TIVO.  Thursday is our last big earnings day with SHLD (got ‘em), TIF, WSM, ZLC, DELL, DDS, DLM, DHT, DLLR, MRVL (got ‘em), PETM, SNDA, LNUX and WIND.  This group also sets us up for a possible rally on Thursday so if we’re still over 11,800 on Wednesday, it might be time to be downright optimistic.

That will be all up to the Wednesday oil report, bogus though it may be as well as that GDP in the afternoon.  It would be nice if no banks collapse (Columbian Bank was shut down on Friday but they were very small).  Actually, "only" 8 FDIC insured banks have been shut down this year in 9 months vs. Whitney, Roubini et als’ prediction that "hundreds" of banks would fail in 2008.  While there are still 4 months to go - they are pretty far behind their pessimistic schedule.  Since the doom and gloom predictions aren’t panning out over here, the doom sayers have now shifted their focus to Europe, where a paper presented in Jackson Hole this weekend now says "European officials have an "urgent” need of plans to cope with a failing bank."

This has caused Trichet (also at Jackson Hole) to defend the response of central banks to the credit crisis. "I would say…what has been done until now has been pretty well done under very difficult circumstances," Mr. Trichet said.   "We still are in a market correction, I think we have exactly the same problem of other central banks."  He joked that he used to be wary of invoking the word "crisis" to describe conditions, even going as far as to call it a "market correction of grave magnitude.  I stuck with that until, I would say, Bear Stearns," Mr. Trichet joked, and now "I speak of crisis."

Let’s not forget that the markets looked like a crisis at the beginning of the week and we barely recovered so we do need to stay on our toes for the week ahead.  Last Monday we were cautious and that served us well by the end of the day when investors were stampeded out of FRE, FNM, LEH and then all the financials based on the same rumors as usual.  Tuesday we had the awful PPI report, which spooked the market but was absolutely no news to us (because we pay attention) so I said "I’ll be a little quicker to remove covers and jump on some momentum plays today if it looks like we’re heading higher - if we can shake off today’s data, we should be looking more forward to a retest of 11,700 than backward to 11,450." 

We did not head higher and fell all the way to retests 11,300 in early trading.  We missed two factors in the morning - Oil went up to $115 again and the dollar pulled back, both were bad for the market.  Nonetheless, at the end of Tuesday I said: "All in all, a rotten day but the volume was low, the VIX was rejected at 22, HPQ had nice earnings so maybe, maybe, maybe GS is the final attack on the financial sector and we can get back to business tomorrow, hopefully along with a disappointing inventory report for the energy bulls."

Wednesday morning we talked about the oil con game and the fact that a bounce off $110 was expected so we thought the markets were overreaction to it with the sell-off.  During the day, there was a surprising 9Mb build in crude inventories yet strangely oil went higher, this was our lucky break of the week as we knew that was complete BS and we picked up several good trades there.  Also on Wednesday night we came up with our "foolproof" FRE plays, let’s hope we don’t end up looking like fools by sticking with  FRE in our Stocks Portfolio…

Thursday morning we were disappointed with Wednesday’s action but we stuck with our plan, removed our covers and had faith in Bernanke being the excuse to pivot the markets on Friday.  That plan could not possibly have gone better as we were choppy in Thursday but did pick up 100 points from our lows (66 officially) and we spent most of Wednesday and Thursday discussing our LTP and looking at adds and rolls there.  By Thursday night, I had to do a Long-Term Portfolio reveiw as we haven’t been this bullish on our LTP in a very long time.   Friday morning I said it was time to stop the madness.  I said in the morning post: "Our bets are already made as we jumped all over the financial meltdown and laughed off the "oil rally" for the farce that it is.  We are heavy long in GOOG and heavy short in SU in the Day Trading Portflio along with our UYG calls so that’s the best indication of our stance for the day."

That couldn’t possibly have gone better for us on Friday and we went into the weekend still mainly uncovered but we’re not going to get carried away, it’s all about the POO next week as well as the new data we’ll be getting.  Who knows what shenanigans will be cooked up by the financial hyenas over the weekend - there’s still a lot of fear in the air and we need to make our levels to become comfortable.  While I was ready to risk the weekend uncovered, I’m not so sure about risking the week - this is where it starts to get interesting!

• After a busy week last week we closed just 42 positions with a 58% average gain. As is typical in the early part of an expiration period, our spreads make our portfolios look ugly but FRE made our $10KX look ugly as our Oct $5 calls took a huge hit and the $7 puts we sold got clobbered too.  That has knocked this portfolio down 30% for the week, now up just 10% overall.
• Our $25KP rode out the week quite nicely as it is our least risky strategy mix and we added 6% on the week.
• The Day Trading Portfolio also added 8%, to 21% overall in this 3-week old portfolio but we have $10,000 worth of FNM common so that may change quickly!
• Stocks Portfolio also got hammered by FRE and lost 9% for the week, we’re down 12% on the common and hoping to get back out of half at $3.21 or better which will leave us well covered on the remainder.
• Our Butterfly Collection did very well, gaining 4% on the week in our safest strategy.  A rapidly declining VIX hurt our callers and we made a couple of good directional calls on BIDU and GS, leading to more than normal gains this early in the month.
• Our timing was perfect with the Long-Term Portfolio but it gained just 2% on the week overall as the VIX hurt our long-term positions and we took the opportunity to buy some more length, rolling back to a lot of relatively cheap 2010 positions - something we’ve been waiting to do since July. 

So a 58% gain on 42 positions closed with flat to declining portfolios.  That means we’re still taking profits off the table quickly in a choppy market but these were our covers so this had better be a bottom or we’re going to have to scramble to re-cover this week: