Holy cow!

I was, ironically, at the Value Investing Congress today where some of the best hedge fund managers in the world like Bill Ackman, Jeffrey Schwarz and, Leon Cooperman to name a few share with about 1,500 investors their thoughts on the market as well as giving us overviews of their portfolios.  The investors I spoke to at the conference were definitely "shopping" as most of them see a great opportunity to deploy cash in the market but I wondered how much of that was reflected by the fact that they had been sitting at a conference with a lot of rich people for 2 days and not watching the markets, like I had been until 11am.

As we discussed in my morning post, investors were not going to be happy with anything less than a massive rate cut (and I’m not sure even that will give us more than a short boost) and we didn’t get it yet and the market fell apart.  Bernanke’s 1pm remarks were the last straw and sent the Dow tumbling below 9,800 and we have now logged our worst annual decline since 1937.

Since I wasn’t going to be around for the day and the futures were looking good at 9am, I posted a list of downside and upside plays for members saying: "I’m heading off to the Investor Conference about 11 but let’s keep an eye on the 10,000 mark to see which way the wind blows.  On the Dow downside, 9,800 provided some support so holding that would be nice if we do head back down."  That was at 9:22.  By 9:36, despite opening higher, I was already not happy, saying: "Not too much strength here, just a follow-through of yesterday’s bounce, a good time to look at a few of those put plays."

The downside plays (hopefully tomorrow we’ll have reason to use the upside) were the USO puts I had mentioned in the mornng post along with DXD Jan calls, DIA Dec puts and, of course, the good, old reliable SKFs.  The market cooperated by giving cheap entries as it continued to rise, as much as 10,118 at 9:43 where I said: "Oh this is just crazy."  11 minutes later, we were already off the high and I said: "There are so many things that are insanely underpriced but this rally is being sold into already so I think it’s just some bottom fishing programs driving the market but no change of sentiment so far.  Still, we are so oversold it doesn’t take much to move things higher but it’s the same air-pocket issue we talked about on Tuesday, when the market recovered too fast to put in a bottom.  We’re just repeating the same mistake today."

So I was, perhaps, the least surprised delegate coming out of that conference today to find the Dow was down yet another 5% and we all know what finishing at the 5% rule means for tomorrow so I won’t even get started on that here - let’s discuss value instead as much of what I was hearing at the conference, given my negative outlook, sounded much like the shouts of people on the Titanic, telling passengers to head for the part of the ship that hadn’t sunk yet.

Whitney Tilson may have nailed it in his opening presentation when he said "In summary, today we are only seeing the tip of the iceberg: an enormous wave of defaults, foreclosures and auctions is just beginning to hit the United States. We predicted long ago that it would get so bad that it would require large-scale federal government intervention – which has occurred, and we’re likely not finished yet."

So great, brilliant analysis - especially since the presentations were due by last Tuesday and many of the PowerPoint slides we saw has 2-week old stats on them, an eternity in this market.  So it is not with criticism of the selections but to illustrate a point that I will mention some of the speakers’ selections here.  Tilson’s lecture was titled: "An Analysis of the Mortgage/Credit Crisis - And How to Profit From It" and his first selection was DISH.  He laid out a very compelling value analysis of the satellite TV company and I agree it is hugely undervalued but, at the time he submitted the slide last week, the stock was at $23.02, just a week later, that compelling value closed at $16.93, down 26%. 

Again, this is a function of the panic selling that is gripping the market, not an indictment of the selection.  FFH was another excellent idea of Whitney’s and I would love them if they come back down and his third pick was BRK.A, calling them a great deal at $138,500 (10/3) but yesterday, even the mighty Buffett fell 5% and finished the day at $124,000.  So what is "value?"  I’m sure that in November of 1929, when the Dow was down 47% from it’s Aug 30th high of 380, there must have been a Value Congress held somewhere and great investing opportunities were discussed.  The market did recover and headed up 50% by April of 1930 but, just 2 years later, in July of 1932, the Dow sat at 41, down almost 90% off it’s highs.

So, at what point do we find "value"?  What is the value of a share of IBM stock to a person who needs to make a mortgage payment on Wednesday?  It reminds me of something written a long time ago in Marginal Revolution about fiat currencies and Gilligan’s Island: "In early episodes, we see Mr. Howell hiring various services from other castaways. We eventually learn he’s been writing checks on a mainland (and therefore inaccessible) bank. This works while the group consider their condition temporary, but the checks are quickly devalued and eliminated when the castaways begin to prepare for the possibility of an indefinite stay on the island.  In Episode 9, "The Big Gold Strike," Gilligan and Mr. Howell find a gold mine on the island, which Howell convinces Gilligan to keep secret from the others. By the time everyone learns about the mine, Howell has already taken the lion’s share of the most easily accessible gold. He’d like to hoard it for himself, but the other castaways begin charging him for their goods and services."

Stocks have "value" as long as investors believe that the economic conditions are temporary but, especially for the non-dividend payers, they are simply not worth the paper they are written on to someone who needs to eat.  Gold is a slightly different story as we are not trapped on a desert isle and, as global currencies are falling fast, gold still holds it’s position as the one thing we can all agree on and there is plenty of room for it to run if the dominoes really start to tumble. 

Bill Ackman, of all people, is seeing value in WB but that was off the $3.91 close in 9/29.  Ackman does think the bank will, in the very least, get a higher price from Citigroup but gave a wide range for the bank’s "value" of between $4.02 and $15.26 a share.  Under the premise that "Cash is King," Lance Helfert and Atticus Lowe like the balance sheets of QLT (down 20% in 5 days), MCF (down 27% in a week) and ATPG (down 40% since 9/29) AND THEY ARE RIGHT!  These prices are insane and the investors on Bernanke’s Isle are operating on the assumption that we will never get out of this mess but when does it end? 

Bear (oops, don’t say bear!) in mind that we had a huge "rally" after the initial sell-off of 1929 and everything looked better for about 6 months but it is widely held that the government’s failure to increase the money supply is what led to the later, much worse, sell-off - along with a very  unfortunate drout that hit the economy at the same time.  Bank failures ground consumer spending to a halt.  Recessions are a natural part of the market cycle, Depressions are a crisis of confidence. 

We are going to get massive, coordinated action from the global central banks and they will boost the market but the quesiton will be- for how long?  As long as we can change perception (maybe Cramer will stop telling people we’re going to 8,000) then we have a chance to arrest this crisis but the cost of global action to prop up the markets is already staggering and I’m simply not sure we can turn these ships on a dime so approach "values" with caution. 

Today’s tickers: BAC, AAPL, GE, VIX, HA, AMT, BCO

BAC – Bank of America – A dividend cut has hurt shares at BAC today sending its shares lower by 15.2% to stand at $27.40. Its option volume is highlighted on our market scanner depicting it as one of the most active today with 235,000 contracts traded. With its shares heading to a two-week low, demand for protection from options has helped lift option implied volatility up 9% to stand at 98.5%.The October 25 strike puts were largely bought at a premium of 1.30 implying a breakeven value of $23.70 at expiration. Bearing in mind that the July low for the stock was set at $18.45, activity of put buying at the November 15 strike stands out today.

AAPL – Apple Inc – Options in Apple are active again but with little footprint left. Overall volume of 178,000 contracts included what appears to be a credit call spread at the January 150/170 strikes involving equal amounts of 10,000 lots. While the 150 strike traded to the middle of the market at 2.29, the 170 strike traded at a premium of 1.04 and were bought. With Apple shares trading at $95.17 (down 3%), this investor might be betting that shares won’t recover by more than 50% by expiration. So long as the stock remains below the lower strike on this combination, the investor retains the net credit of 1.25 per contract. On both of these out-of-the-money contracts the entire premium consists of only extrinsic value and its time value erodes by the day.

GE – General Electric – Shares of industrial conglomerate GE are higher by some 2.9% to $22.00 today, while implied volatility has contracted by 11% to 63.5% after shares reached rock-bottom on Monday at $19.72. Overall options volume of 89,000 lots ensures them a placing on the most active market scanner. Some optimism may have returned to equity traders but option investors were more cautious. They sold October calls at both the 20 and 22.5 strike while October 22 puts were bought.

VIX – CBOE Volatility index. – Options volume eased somewhat on VIX options today as equity indices stopped falling. The activity stood out in the October VIX options, where despite a decline of 9% in the underlying index to 47.36, premium on October calls rose. The reason behind the rise is due to the fact that the October future also rose to 37.70 (+0.9%). As we approach expiration on October 21, the futures get dragged closer to the underlying cash VIX index. It seems that option traders perhaps took advantage here and largely sold call options at the 30 and 40 strikes perhaps anticipating that yesterday’s big spike in the underlying will turn out to be as bad as it gets. Of course, traders also have time on their side, that is, assuming no major catastrophes in the very near future.

HA – Hawaiian Holdings Inc. – With its shares lower by 1.1% at $7.15 today it appears that an investor may have rolled a long call position down a strike in the April ’09 contract. Existing open interest was established one month ago at the April 10 call strike at a premium of 1.90 and it appears that this might have been sold at 65 cents in exchange for a similar volume play at the lower 7.5 strike at a premium of 1.36 today. At the lower strike today’s volume exceeds current open interest while implied volatility of 86.5% compares to an 80% reading on the underlying share price.

AMT – American Tower. – A slight recovery in its share price was accompanied by elevated option activity detailed today in our market scanners. With shares higher by 0.4% at $33.48 there were two chunks of put options in play today. In the October contract the 37.5 puts were sold 10,000 times at a premium of 3.80, while at the January 35 strike some 12,400 contracts were bought at 4.80. It could be the case that an investor is rolling his protection down the strike price and is prepared to pay a larger premium while likely locking into some profit on the open put position created while AMT shares slipped from $42.50 during the past eight weeks.

BCO – The Brinks Co. –. Shares are higher by 5% at this home security company at $53.55. A sizeable call spread has gone across the tape at a net debit of 8.10 per contract involving the November 45 and 60 strike calls. The lower calls were purchased and the upper strike sold. Should the shares breach the 60 strike at expiration, the investor is looking at the maximum gain as defined by the 15 point distance between the two strikes minus the cost of the trade.

September was a tough month but we did very good getting through it without panic. Congratulations on some great trades in the comments everyone, especially in the last days!

I expect the market to become less volatile and that should give us some great trading opportunities.

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- Optrader

Was Cramer right yesterday?

Should we all be removing what we need to live on for the next 5 years from the market?  He made that statement on yesterday’s Today Show and, when Ann Curry asked him "Even if you would take a tremendous loss in selling your stocks at this decline, you say take it out?"  Jim’s answer was "I don’t care.  I do not care where stock have been, I care where they are going, I do not want people to be hurt in this market."  It’s good that Jim doesn’t care as there was a low-volume, massive sell-off that was indicative of retail capitulation followed by strong waves of program buying indicative of Jim’s hedge fund buddies jumping in and scooping up the bargains.

At least Cramer gave us a good bottom test so we should thank him for that, I drew up a new Big Chart last night and it is truly terrifying how far we have fallen and even more terrifying when we look at Asian markets and see how far we may still have to go if things do not turn around very soon.  Both the SOX and the Transports are more than 40% off their highs of last year and the SOX are teetering right on the 50% line at 274.  If they go down, there is not much hope for the broader markets and it will be time to re-up our ultra-shorts for the next leg down.  The TRANQ (Nasdaq Transport Index) is already below 40% after dropping 72 points yesterday (and that is AFTER a 100-point recovery) and, if they don’t retake 1,868, I wouldn’t put much stock in a "recovery."

Let’s keep in mind that last week we were worried about breaching the 25% lines on the Dow and the Russell as a sign that we’d get a broader decline.  As I said last Tuesday morning: "The Dow MUST NOT cross that 10,644 line again as it’s a long, long way to the bottom that is being shared by the Hang Seng and the Shanghai at 50% off the highs (that would be Dow 7,000!)."  Unfortunately, we coasted along that line last week, before we well and truly gave it up on Friday and now we need to get it back before we can really do anything more than day trade to the upside. 

The upside will be severely tested this morning as BAC pre-announced a lower profit and cut dividends in half while Iceland took control of it’s second-largest bank today, borrowing $5.4Bn from Russia to prop up the nations’ finances.  Iceland already took over the 3rd largest bank last week and loaned $700M to the largest bank to try to avoid taking that over too.  Bank assets in Iceland are nine times the $19Bn GPD of the country and the Krona has gone from 131 to the Euro to 200 to the Euro in the last few weeks.  As with LEH in the US, the failure of Iceland’s banks could spread around Europe as they are heavy investors in other EU banks and corporations (there’s not much to invest in in Iceland).

India boosted the Banking sector by cutting its cash-reserve ratio in order to quickly put liquidity into the market and they also made moves to attract foreign capital by removing restrictive regulations.  Short-term money market rates in India have spiked up to 16% from a normal 6% but the rupee is in free-fall so it’s not such a great return.  Again, do not think this can’t happen in the US - currencies are a funny thing when Central Banks start messing around with the economy.  Nonetheless, the BSE fell 1% on the day, 46% off it’s highs at 11,695. 

Australia made an emergency rate cut, a very logical move for a commodity-driven economy but the BOJ held steady at 0.5% (not much room to cut) and the Nikkei fell 3% after failing to recover off a huge morning gap down and the Hang Seng was closed for the day.  "Credit markets remain in gridlock, credit spreads remain wide, and this credit crisis which started in the U.S. over a year ago has well and truly gone global," said ANZ Bank’s New Zealand chief economist Cameron Bagrie. "It remains to be seen how Asian financial institutions hold up. This could well be the next stop."

Europe is trading mixed ahead of our open, which is not bad considering the bad news in Iceland but the markets there, along with our futures, were up considerably ahead of the EU open (3am) on anticipation of a coordinated, emergency rate cut.  Much like our own Congress though, the EU could not get it together and agree on a course of action and the markets plunged at the open and have been struggling to recover as they head into the US open. "Europe must prepare to put in place a collective line of defense," said Dominique Strauss-Kahn, director general of the International Monetary Fund, in a speech in Paris on Monday. "The stability of the world economy is at stake." 

Meanwhile, Russia’s massive bailout has been a disaster as the RTS dropped 19% yesterday, a full month after $120Bn was put into the markets, a larger percentage of GDP injection than the one Congress just approved in the US. Investors have complained that a lack of detail about the bailout, as well as its slow implementation that has sown fears about whether it will be competently handled. "In the current environment, its not clear that a package will work anywhere in the world," said Charles Ryan, chairman of Deutsche Bank in Russia.  "No matter what the fundamentals, [investors] are afraid that tomorrow everything will be cheaper than it is today."

When Russia announced its bailout last month, the government was praised for its quick action in rescuing flailing financial markets and providing a massive infusion of funds to restore trust between banks.  The package included up to $20 billion to buy stocks, and $60 billion in deposits at banks to boost liquidity and billions more to banks via repurchase operations.  Four government-controlled banks have received many of the cash infusions, but little money has been lent amid persistent fears about credit problems and counterparty risk.  "There’s all this money promised, but so far it’s not on the market," said James Fenkner, head of Red Star Asset Management in Moscow. "Banks are still not lending money to each other. It’s disheartening, because the government was supposed to do something."  Hopefully the US will learn from Russia’s mistake but, then again, we did start a war in Afghanistan after seeing Russia fail at that for 10 years…

In keeping up the $200Bn a day average that the government has been pouring into the system for the past two weeks, the Fed unveiled  a new lending program aimed at helping U.S. banks finance purchases of a kind of commercial paper called asset backed commercial paper, which is secured by collateral such as securities backed by mortgages or car loans.  The move was aimed at stabilizing money market funds that were being forced to dump illiquid or risky holdings as investors redeemed their money.  I discussed the need for action in commercial paper in Friday’s post and the Fed has a $600Bn gap to fill here. 

Its going to be rough sledding in the markets and investors will not be happy with anything but a massive rate cut.  Obviously we can now use Dow 10,000 as an indicator to get in or out of our puts and ultra-shorts.  Oil is also being kind enough to give us another opportunity to short it at $90 and it’s a long way back to $70 if we have a long recession so the USO Apr $78 puts are pretty good looking at about $13.50 (last sold at $14.50) as you can pick up a quick $3 selling the October $71 puts with plenty of good rolls to November. 

We have Fed minutes this afternoon but the market is clearly in panic mode and we get the Consumer Credit Report at 3pm.  Tomorrow is Pending Home Sales and Crude Inventories and Thursday we are back to Jobless Claims and Wholesale Inventories, which may give us an early indication of the holiday season.  Friday’s data is limited to trade so not too much to go on and it is going to be all about the Fed this week.  Earnings are so far, so bad and AA reports tonight along with YUM but I’m getting concerned about the retailers as this credit crunch may ruin Christmas - more on that tomorrow…