Tuesday, February 5, 2008

Added delta to SIRF and WB amid market freefall

Another day with blood in the streets. Institute for Supply Management (ISM) non-manufacturing survey results are out early and they don't look good. Survey says: Recession. Panic ensues and we get another 3% drop across the board.

Keep in mind that this is a survey and if everyone is flooded with recession news, they will believe that a recession is coming. This is also known as anchoring bias.

The hedges that I put on a week ago seemed dumb at the time (and a bit early) but they drastically cut my losses today. Without hedges, I am about ~4x leveraged and with them, I am about ~2x leveraged. However, some of my hedges are running out of premium (probably a good time to buy the calls back). In general, my portfolio has a naked put / covered call profile where I am long delta with negative gamma. So as the prices decrease, I am getting more delta. This fits well with my value based strategy. As prices decrease relative to value, there is a better risk/reward tradeoff and I am willing to take on more delta.

I have been reluctant to buy after the rally last week since I've turned more bearish while the market sentiment turned more bullish. I also could not understand why prices should go up given the constant stream of bad news. The rationale that bad news => fed cut => financial recovery is silly. It's like saying mortgages are good cause the government gives you a tax break on the interest. Rate cuts are weakening the dollar and causing a rise in commodity prices which are increasing costs for businesses. On the other hand, rate cuts are not increasing consumer spending due to constrained credit (i.e. banks are do not want to lend at these lower rates since they would rather use it themselves as capital). The 'consumer led recession' is leading to demand destruction. When supply decreases (due to higher inputs) and demand decreases (due to lower income), equilibrium output decreases (i.e. GDP decreases). And GDP decreases define recession. So, recession, here we come. But the word doesn't really mean much to me per se. I see it as an opportunity to pick up more assets at a lower cost. Capitalism at its best. I actually hate bull markets because it is hard to make a living as a put seller since I try to have enough discipline not to chase stocks. On the other hand, I love to sell insurance for quality companies at low prices and high premium (thanks volatility).

SIRF gave really bad 2008 guidance. 6+ brokerages smacked it with downgrades. Stock is down 55%. GPS technologies are good, but consumer electronics are bad. Niche analog semiconductor companies are good, but semiconductors are bad. Basically, I see SIRF as a good growth company hit with bad macro trends. However, I think they will do ok in the coming slow down. GPS devices are so competitive that the price reductions will be hitting the device manufacturers hardest. Sure things are bad but not 7 a share bad. SIRF has never traded at this level before. Although they have been issuing shares and diluting shareholders, it isn't that bad. Take a look at the past annual reports. I checked the current ratio and did a few quick solvency tests and they seem to be able to whether the storm. I doubt they will continue to issue shares at these prices (if they do, the management need to be replaced). We might even see a share buyback. The 1.4 a share in cash also doesn't hurt.

I sold a bunch of Feb 7.5 puts at around 0.5 and a bunch of Mar 7.5 puts at around 1.25. That would give me an average cost basis of approximately 6.75. Backing out the cash, that means I'd be paying 5.35 a share for a growing business in a great segment. That's me rationalizing my purchase; it could turn out to be stupid but analyst downgrades always make me over confident.

I also sold some Mar 30 WB puts as I have been doing for the last couple of months.

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