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By Ian Wyatt, Daily Profit |
GM | Nov 21, 2008 |
Your Daily Profit
November 21, 2008
*****All GM, All the Time
*****Another Short Ban?
*****Reader Mail
*****Yesterday’s trading seemed to be all about GM (NYSE:GM) and the automaker bailout being debated before Congress. The Dow Industrials traded within 11 points of October 10 lows at 7,773 in the early going.
News hit the wires shortly after noon that the Senate had agreed to some form of bailout. That sent stocks launching into positive territory. The Dow was up 180+ at one point.
Sometime around 2:30 news hit that Congress had a few hoops for the automakers to jump through before they’d see any cash. That was the final nail in the coffin of today’s trading.
Of course, the economy’s been wielding a pneumatic nail gun that’s shooting handfuls of nails on any given day. Today it could just as easily been unemployment. Or the influential index of leading indicators. Or a Philadelphia Fed manufacturing survey that showed manufacturing slowing at the fastest pace in 18 years.
It could have been JP Morgan’s (NYSE:JPM) announcement that it was cutting 10% of investment banking staff. Falling oil prices, falling commodity prices and new calls for short-selling bans also make the list.
*****The Dow closed at 7,552 yesterday. That’s significantly below the 8,175 support level we’ve been watching. It’s well below the October 10 lows at 7,773.
You have to go back to 2003 to find support levels. And those were the lows after the Internet bubble and 9/11. All I can say is a rally should be coming. Because the alternative is not pretty.
*****The short sale ban is particularly annoying. For one, it’s not effective. Stocks fell just as much, if not more, the last time the SEC enacted this ill-advised policy. Second, why should investors be denied every possible avenue for recouping their losses? Short-selling is a perfectly legitimate method of trading. And if you haven’t employed short-selling or a short ETF to help mitigate your losses, you’ve been missing an opportunity.
And third, the last short sale ban caused a lot of turmoil for hedge funds that were doing long convertible bond/short stock trading. This trade allows the fund to collect bond yield payments with no risk. It involves buying corporate bonds that can be converted into stock and pay a certain percentage premium. A like amount of stock is then sold short.
If the stock rises, the bond can be converted into stock to cover the short position. If the stock falls, then the fund profits from the falling price. Either way, the fund collects the bond premiums.
But when the short sale ban was put in place, it ended that trade. Hedge funds were forced to cover their short positions. And without the ability to hedge their convertible bonds, they dumped those into an already difficult market. That just sent prices lower and raised the cost of corporate borrowing. The previous short sale ban is part of the reason the Fed has been buying short-term corporate bonds.
*****“Old Man” Bob wrote “Cramer says that if GM, Chrysler and Ford aren’t bailed out the Dow will drop 2000 points. He is advising everyone to sell everything before this happens. What is your opinion? If all the people watching him sell we will be in a depression worse than the 30’s. What in the hell do we do? Sell if no bailout or watch our portfolios go down the crapper.”
If Cramer said this, he’s nearly halfway to his prediction of a 2,000 drop after today. The market clearly doesn’t like the idea that the Big 3 might fail. Taxpayers should be a little unnerved that the CEOs from the Big 3 flew to Washington in private jets to beg for money.
I can tell you that Cramer is a smart guy. He’s also part entertainer. People don’t follow his advice in droves. Congress is forcing automakers to submit turnaround plans before lending them any money. I’ll bet they’re already working on it.
As for watching your portfolio dwindle, if I new what was going to happen next, I’d tell you. I happen to believe that stock prices are closer to a bottom than a top and that investors should be looking for long-term opportunities. But here’s a quote I came across today that’s pretty insightful. It’s from the Chief Investment Strategist at Wells Capital Management. He says “This isn’t about fundamentals, it’s not about bad balance sheets, it’s about fear and confidence.”
In other words, we should be paying more attention to investor psychology than stock valuations right now. What’s it going to take to make people feel better about buying stocks?
*****Alan W. sums up the fear and lack of confidence: “I am ready to sell all my stocks and funds and hope the rest of the country does too. The Autos should be saved with a lot more then just 25 b. If AIG is saved why not the autos? You money people don’t give a damn about us. Lets hope all of you are out of a job. Who do you think you make your money from?”
I sympathize. It’s maddening to watch companies like AIG who made incredibly risky and downright stupid moves get billions upon billions in taxpayer funded loans.
But what’s the alternative? Stand by and watch our financial system crash? That would truly kick off another Depression, complete with 25% unemployment or more. As for GM, its failure won’t cause a Depression. In fact, Chapter 11 bankruptcy would give the company toe to restructure and send a strong message to the UAW that business as usual is over.
As for me, I make money from subscription sales to my three newsletters (Top Stock Insights, Growth Report and Rising Star Stocks) and my trading service (TradeMaster Daily Stock Alerts). It’s pretty simple – if I don’t provide winning stock picks and trades, members cancel and I and my staff don’t get paid.
That’s a far cry from how Wall Street works. Which brings me to a comment from Paul D. “I read your article and think we should not confuse “free” with “irresponsible” or downright “fraud”. Free and responsible go hand in hand.
What is happening now is that the house of cards built on irresponsible excessive debt has come crushing down. Until such time as debt levels (government, corporate and consumer) are brought back to acceptable levels this turmoil will continue. Debt has never been and will never be a good asset.”
Paul is referencing an article I wrote where I criticized George Bush’s statement that the current financial crisis wasn’t caused by a failure of the free market. I countered with this “I beg to differ. That’s exactly what it was. The market was too free.
Greenspan said as much when he confessed that he thought the market would regulate itself.
Of course I’m not talking about the market you and I understand. Companies should be free to do where and with whom they please. And if another company can do it better, or cheaper, it’s adapt or die.
The market I’m talking about is the one where investment banks are free to invent whatever financial products they please. And if they can get credit ratings on them, they sell them. It’s also the market where insurance companies can insure things they don’t understand and have no models to identify, much less manage, risk.
It’s crystal clear that some aspects of markets absolutely must be managed.”
I agree with Paul, the Ayn Rand-ian utopia sounds great. Free and responsible should go hand in hand. But that doesn’t mean they do. In fact, if stock market history has taught us anything, it’s that greed will triumph over responsibility almost every time. For more of my thoughts on the matter, read this Daily Profit from October 24, 2008.
Now as for debt, I have to disagree a little here, too. Without debt, how many Americans could buy a house? Not many. Our ability to own things like houses and cars depend on debt.
So too do many aspects of our economy. How would highways ever get built if states couldn’t sell bonds to pay for them? Sure, in ancient times, the pharaohs had a great plan for funding public works. They simply used slaves. So did the Romans. But that’s frowned on today. Debt is the only way to direct resources to necessary projects.
It wasn’t the excessive levels of debt in the housing market that brought down the mortgage-backed securities “house of cards.” It was the fact that debt was sold, and then leveraged and then insured and then sold again that’s the problem. That’s how debt became the asset that Paul talked about. And he’s right that using debt as an asset is a risky business.
If you read corporate balance sheets, assets area always offset by debt. In the case of mortgage-backed securities, the risk that the debt would not be paid was grossly understated, and so the asset was grossly overvalued. Wall Street totally mismanaged risk, with disastrous consequences.
*****Steve B wants to know about the “Mom cancels Christmas” trade: Walmart puts—Can you describe how this works in detail and the timing decision points.
For those that missed it, you can review the trade Steve’s asking about here.
Now, a put option is a type of derivative. Any derivative is a contract, an agreement between two parties. An option is a contract whereby one person buys the right to buy, or sell, 100 shares of stock at a specified price. Option contracts do expire, and the time frame is spelled out in the contract.
The concept of buying an option is used all the time. In real estate, a developer might buy an option on a parcel of land. This buys him time while he seeks financing or does a feasibility study. In sports, teams often pay for an “option year” on a player that gives the team time to decide if they want to extend a contract.
With stocks, an option contract gives the buyer the right to buy, or sell, 100 shares of stock at a specific price, within a specified timeframe. Call options give the buyer the right to buy 100 shares of the stock. Put options give buyer the right to sell 100 shares of the stock.
So in the case of the “Mom Cancels Christmas” trade, I sold January 47.50 Wal-Mart put options. That means whoever bought that contract paid $265 for the right to sell me 100 shares of Wal-Mart stock at $47.50 a share. That person has until the third Friday of January to do so, or the contract expires.
I then took the money I received for the Wal-Mart put options and bought March 19 puts on the S&P Retail SPDR. That means I can sell 100 shares of the XRT at $19 each. And I have until the third Friday of March to do so.
This trade is working great so far. Wal-Mart has strong support at $50. I’m betting that it won’t drop below that level. So long as it doesn’t get below $47.50, nobody will want to sell me 100 shares of Wal-Mart stock for $47.50. They’d lose money. And I want that put option to expire with no action being taken.
The XRT on the other hand, is selling off almost daily. It’s now well below $19. I’m making money. And the longer Wal-Mart stays above $47.50 and XRT stays below $19, the better I do.
At some point in the next month or so, I’ll close this trade. Black Friday is next week, and while expectations are low for holiday shopping, you never want to get caught by big news events when you’re holding options. To close this trade, I will sell the XRT puts, and then buy back the Wal-Mart puts. At present, this trade would net me $150 per trade unit, minus transaction fees.
*****One last question, from Gail K. Are Graham Corp and Emergent Biosolutions still good buys?? Or have they gone up too much???
Obviously, this question came in before yesterday’s utter meltdown. And in light of that meltdown, I’d say there are some pretty good upside trading opportunities. Both of these are good candidates. So is Questcor (Nasdaq:QCOR).
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