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.

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.

Senate hijinks on a Thursday of expiration week

I am not sure why politicians want to create havoc for options traders but apparently that's the thing to do. There is a banking committee hearing where Bernacke and Paulson testified. Bernacke some how mentioned that there are more write downs to come. As a result, the market is down across the board.

Also interesting is the NY investigation into the monoline bond insurers. There's a lot of stick waving to convince them to merge or sell assets to Buffett. Somewhere in the conversation, there was threats to strip the muni assets forcibly. All the bond insurers have to say is: Blame it on the shorts. Interesting situation to watch.

Since it's a crazy day, here's a quick take of the positions I am working on:

Wachovia (WB): Looking to add additional delta in the form of March / April 30 puts on the pullback. I think the banks have been kitchen sinking it and we might even get write ups.

Nautilus (NLS): Down after earnings as I expected. They reported total kitchen sink quarter. Tried to pick up some more (I already have a huge position put on from 10 to 5 with an average cost of 8) on the way down at 3.75 but missed it. Not going to chase it on a day like this. Got orders in place for 3.75 and 3.50.

NVIDIA (NVDA): Saw it on the newsfeed and reflexively trying to add March 22.50 puts for 1.50.

EMC (EMC): Trying to buy to close the Feb 17 puts I have for even (take a hit on the commissions). Already have some Mar 15 in place, will sell more naked puts on movements down.

Microsoft (MSFT) bids for Yahoo (YHOO), Short XHB?

I missed the boat. The 31 a share offer from Microsoft for Yahoo has pushed the price to the 29 level. I got a bit greedy with how much premium I was trying to sell the put options. I could have made instant bank but now I got nothing.

On another note, this rally makes me want to short the S&P Homebuilders ETF (XHB). The market seems to be on looking at the good news and ignoring the stream of consistently bad economic indicators. Even though the government is bailing everyone out, the homebuilders are pretty low on the list. I tried to short a small position (just to see what it's like since I've never actually shorted stocks before) but couldn't borrow any shares. So I guess I have to just sell calls on it.

I also got out of some DRI options. There's a good chance it is going back to 20. Casual dining is a tough business right now.