Wachovia (WB) surprises, but not in the way you think

Wachovia (WB) reported Q1 2008 today with a loss instead of the profit expected by analyst consensus. Dividend was cut to $1.50 per year. Neither of those things were surprising. In fact, I would argue that it was mostly priced into the options premiums.

The surprise was that they pushed up earnings from Friday to Monday. This hasn't happened to in recent memory and as a result, I was caught with some positions that I wanted to close / roll down. But overall, it was a cheap lesson. A few hundred dollars for a lesson that there are temporal surprises.

Still long Wachovia (WB) through a variety of naked puts. I am trying to figure out how exactly to position myself going forward. The pricing of new common stock at $24 is reassuring since that sets a near term bottom (the new issuance was oversubscribed).

I have been building reserves (not unlike banks) so that even with a 10% drop in a core holding no longer threaten margin calls. I have been deleveraging by reducing the number of share I hold. For example, suppose I have 200 shares of BBBY get called away at 30. I would normally write 2 naked puts at 30 for the next month. Recently, I would instead write 1 contract. This is a natural deleveraging that does not force me to realize losses unnecessarily. Also, I have been closing winning positions that no longer have sufficient reward for the margin required.

General Electric (GE) gets hit by an earnings miss

From GE investor relation: GE announced first quarter 2008 earnings from continuing operations of $4.4 billion with $.44 per share, down 8% from first quarter 2007.

As they say, "the market has a paddle big enough to give anyone a spanking". Nothing could be more fitting when the second largest company in the world by market capitalization (eclipsed by XOM due to the recent rise in crude). GE is down a whopping 14.66% or 4.70 to 32.05.

Not long ago, Jeff Immelt all but promised 15% growth this year. GE hasn't missed a quarter in years and even when it did in 2003, the miss was a penny. A 7 cent miss is huge for GE.

This is another example of the long tail of equity pricing. Stock prices do not follow a normal distribution; they have long tails. This is also known as Taleb's Black swan theory. Every options trader should be very comfortable with the idea that substantial moves happen more often than predicted by models. Such rare events is what makes naked options more dangerous than the statistics would predict.



Now back to GE. Industrials were strong due to currency and rest of world demand. Appliances down due to housing crisis. Financials down due to mark downs. Healthcare down due to lower demand for capital diagnostic equipment. None of this is surprising, per se. I don't know why analysts didn't bring down estimates.

I was slightly long GE before this (long the stock, selling calls against). I see this as an opportunity for me to pick up for shares for a great price, 15x trough earnings. I am selling at the money puts for June and September. The options markets are not increasing the implied volatility. This is bad since it means I get less time premium. This is good because it says that options traders are optimistic. Either way, I am reserving extra capital to handle a dip (since I am at the money) and in case of a volatility spike (since IV is low).

Beware of Cramerica - Wachovia (WB) price action

Just thought this was interesting... Jim Cramer said all banks are a sell yesterday. In after hours Wachovia (WB) trades down 3%.

Today we get a massive rally that pushes WB up 10%.

If you listened and blindly followed Cramer, you are out 13%. And if you listen to others it is hard to get the conviction that lets you stand firm. I bet a bunch of those selling after hours are back in at these prices.

Beware of bad quotes on TD Ameritrade and Prophet

Hope everyone had a good trading day.

I don't know if it was because of the volume but after the fed today, Prophet charts were very spotty. I also noticed that options bid/ask on Ameritrade was broken. Trade execution worked flawlessly and I got a couple trades done (mostly rolling out calls). Keep an eye on it and be careful. Yet another reason why you should always use limit orders.

For example, AEO May 17.5 Puts were being quoted on Ameritrade as 0.75/0.75 or 0.75/0.85 but the actual quote was 0.65/0.75.

I am going to try to avoid the market the next two days due to the quadruple expiration.

JP Morgan (JPM) buys Bear Sterns (BSC) and Fed cuts rates

As many people guessed, JP Morgan (JPM) is buying Bear Sterns (BSC) with guarantees from the Federal Reserve. (For once, CNBC was right.) The Fed also cuts 25 basis points.

I am really worried now. For one thing, the price for the JPM takeover of BSC is $2. Does that mean the shares are going to open at $2? Why were there so many dumb people in it at $30-35? I mean, even CNBC kept saying that equity was wiped out. If BSC was so mispriced, are other banks also mispriced? I guess we'll find out when the market opens.

Why cut rates when there is a FOMC meeting on Tuesday? Doesn't that signal the Fed is panicking?

I have a feeling that Monday is going to gap down on heavy volume (don't have any theories, just a feeling). The news doesn't make me feel confident.

Short Idea: True Religion Apparel (TRLG)

I was listening to the American Eagle Outfitters (AEO) conference call and noticed that women's bottoms (denim in particular) was weak and that AEO is revamping the entire jean line for the back to school season.

So this gave the idea that True Religion Apparel (TRG) would be an interesting short. They make high end jeans. High end is bad when consumers are trading down. Jeans are bad (apparently, due to some fashion cycle which I don't understand). TRLG is currently trading 17x earnings while AEO and many other apparel retailers are trading around 10x earnings.

This is the first of many such quick pitches I plan to do to give my readers ideas for their watchlist (which I am always in need of). I haven't done any due diligence but I am definitely watching TRLG. I am thinking of either shorting it or doing a long/short pair with AEO to reduce sector risk.

I don't like much about Jim Cramer but I do like the fact that he knows a little about a lot of stocks. Someday I hope to copy that trait.

Covered calls, straddles, and strangles as hedges

As they say, the trend is your friend. S&P 500 is failing to breakthrough 13 day exponential moving average (EMA). I am taking this opportunity to fade the rally by adding hedges to my positions.

Most of the losses I have been suffering in this downturn have been to long positions I am holding. So today, I sold a bunch of calls slightly out of the money (OTM) 2-3 months out on many of my positions (i.e. covered calls). In addition, I am trying something new and selling call options naked against in the money puts, essentially turning them into short straddles or short strangles. I also sold some calls about support on my mess of Wachovia (WB) puts that gives me a weird P/L curve. It is basically a weird ratioed straddle with different months on the different legs. The P/L curve shifts right and up over time. The up shift is due to time decay (i.e. positive theta) and shift right is because my positive delta positions are longer duration than the negative delta positions. That is, the puts I sold are farther out than the calls I am selling.

In addition, I also sold some Washington Mutual (WM) short to hedge against my WB position. I don't usually short stock so this is somewhat of a toy position to gain experience.

This liquidity injection is a bailout.

A 200 billion dollar liquidity injection was announced today. The Fed and other central banks are essentially willing to lend on mortgage backed securities (MBS). This includes agency backed (the stuff Annaly / NLY, holds) and AAA private label (the stuff Thornburg / TMA, holds). While NLY, TMA, and the like cannot directly borrow from the window, companies like Bear Sterns (BSC) can.

This is the capitalist version of nationalizing MBS. The Fed is essentially willing to be a buyer of last resort for these securities for a discount.

The market reacted with an incredibly strong rally. I am guessing it is a combination of short covering, bouncing of January support, and this bailout.

Leverage works both ways and this 3-4% across the board gain is a gift. While I believe the rally has legs, I took the opportunity to unload a bunch of positions into the rally. I need to de-leverage my portfolio and I am not going to give up such a chance. I closed my front month Mar 33.50 ADSK puts, Apr 33 GE puts, and Apr 35 WAG puts. Nothing wrong with those companies per se. Closed ADSK and WAG for the margin. Closed GE because it broke its long term 33 support and there might be a chance to grab it lower.

Given that there is P/E compression across the board, I am revising the price at which I am willing to take assignment of stock lower. So as a risk management move, I am closing many puts that have too little reward for the risk taken. Fading the rally, so to speak.

The 14% gain in Wachovia (WB) was great since that is the stock that is causing me margin calls. My strategy right now is to recover margin and stay in the game until March options expiration. Then I am going to sell some calls against the WB that I will likely be assigned.