Closing Hedges on Wachovia (WB) and Bank of America (BAC)

Short selling restrictions lapsing on broker-dealers combined with options expiration week (lots of open interest with strikes below the current price) means that we are seeing downward pressure. It might be temporary or it might be another few weeks of financial doom and gloom.

Either way, this is a good time to take profits on any calls (naked or covered) on financials (WB, BAC, BCS). I am closing some August 17.5 and 20 WB calls and also closing some September 20 calls. The plan is either to write lower strike calls for more time premium or to wait for an uptick. Which happens depends on price action for the rest of the week.

Gasoline Turnaround? Reducing exposure to refiners (VLO, TSO, FTO)

Valero (VLO), Tesoro (TSO), and Frontier Oil (FTO) are my favorite refiners. I use them to play the crack spread. They are ideal for put selling because of high volatility and strong book values (refineries are easy to value at replacement cost times some modifier).

After a 4.3M draw in gasoline inventories vs. 1.3M expected draw, refiners are up ~10%. So I am taking some positions off the table. In particular, FTO Aug 17.5/15 Put spread and TSO Aug 15/12.5 Put spread. I am hoping to sell another similar spread in Sep options on any pullback. If this is actually a turn around, naked puts in FTO, TSO, and VLO will be making money. So I am leaving those on the table as they are several months out and I am near breakeven.

Nice to have a stable day after a massive rally, even if you are taking loses are hedges.

Opportunity in Wachovia (WB) in market whipsaw?

On Friday, the markets was just plain ugly. A look at the advancers vs. decliners for all the major averages will tell you that almost everything was down.

In particular, I am options with intrinsic leverage on underlying securities with a high beta in sectors leading the market decline (consumer discretionary). So, my leverage vs. the market on a down day like this is somewhere between 3x and 4x. That's a 10% drop in one day.

I went through a did a through check of all my portfolio positions and I think I will be ok if I can make it through possible margin calls. I have a couple of positions (ADSK, NVDA, EMC) that were written at the money for the front month and are now in the money and at risk for assignment. I have enough cash and margin to take the assignment. I am more concerned about the overall margin. Since TD Ameritrade does not use portfolio margin, margin is often a concern for my style (which has high drawdowns). We'll see what happens next week. I might have to close some of my longer term puts (which are currently making money) for some buying power.

I spent most of Friday listening to conference calls (there's no reason to listen to CNBC on a day like that; it just makes you more emotional) but I did manage a few trades. With a review of the last Wachovia (WB) quarter, I am still convinced that they will be fine in the long run. I am not saying this is a bottom. I fully expect more writedowns. In the conference call, WB management gave the impression that they are properly reserved for a 60 basis point loss (triple their normal rate) on their Pick-a-Pay (what WB calls Option ARM) loan portfolio. However, looking at recent data and the 'vintage' charts, there is a good chance that losses will soon be estimated at 80 bps or higher. In addition, the auto portfolio looks pretty bad too but that's reasonably small. There is also the risk of canceling the dividend. They don't need to right now but it is an easy source of additional capital. Either of those things might pressure the shares. However, I think the risks are priced in for long term buyers. So I sold a bunch of WB naked puts for multiple months out and at various strikes. This should more than double my WB delta.

I also closed out my XHB naked calls. I am not going to be greedy so I took the 60% gain in two days.

We'll see what happens Monday. If we get additional downside, I am going get more defensive and close out everything that I don't need for additional buying power and then start adding more delta to all my conviction buys (to steal a Goldman Sachs term).

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.

And here comes the crash, well maybe.

I am all excited because the markets are down and I don't feel so bad about putting on hedges. I really wished I had been able to short XHB. Instant 8% right there. Oh well, all my consumer discretionary are tanking (AEO, BBBY, HD) as well as many of my financials (WB).

I am short a bunch of the near month in the money calls so today is not bad. I am still losing a 5% on my portfolio but given the leverage I am using, that's a good day.