by Michael Shulman 05/21/08
When the world's greatest investor actually deigns to do some charity work, my friends, it truly means we are living in interesting -- and potentially dangerous -- times.
In mid-February, investing mogul Warren Buffett offered to bail out the insurers of municipal bonds -- on his terms, of course -- which would have meant that a serious profit will likely accompany his seemingly no-strings-attached act of do-gooding.
But in early March, Buffett withdrew his offer to guarantee $800 billion of municipal bonds backed by the three largest bond insurers MBIA, Ambac Financial Group and FGIC.
News like that shows just how grave the situation in the credit markets truly is, and as this reality sinks in deeper, the question for those of us involved with options trading is how much overly optimistic or value money will prop up the financial sector in the meantime. From where I stand, there isn't enough value money coming in to support the financials for anything longer than the short term.
As my friend Toby Smith said recently, "A few rate cuts and a scolding from the central bank is not going to end the unwinding of the Great Financial Mirage of the 21st century -- trillions of dollars' worth of investment bank and deposit-taken bank profits that turned out NOT to be profits at all."
Everyone on Wall Street has been looking toward the Federal Open Market Committee to fix the lenders' problems with interest rate cuts. And even though it's not the FOMC's job to clean up the mess on the Street, it has stepped in to provide much-anticipated cuts that investors wanted to see.
But, while investors want to see even more rate cuts, the market is pricing them in and the bullishness that typically accompanies Fed action is having less impact each time around. And there are no guarantees that Dr. Ben Bernanke and his governors will continue to bail out the lenders, or that any further action on the Fed's part can even provide enough relief to these troubled companies.
In that vein, my theory on the financials is quite simple: If the banks aren't making money, then let's short 'em and make some profits of our own!
The credit squeeze is tightening, and all signs point to further pain on the horizon. We've had some great success with shorting the financials, although we stepped out for a while in January when the Fed made some emergency interest-rate cuts that served to give a short-term boost to the ailing financial stocks.
However, even though the Fed recently offered $200 billion in loans to financial institutions in an attempt to delay or even avert a global credit crisis, it isn't going to solve all of the banks' problems.
I also think the Fed will disappoint the market and cut interest rates less than expected the next time around. And this gives us several weeks to not only watch the credit markets continue crumbling, but also to make some sweet short-side returns along the way.
The bond market has priced in a full 100-basis-point (or one full percentage point) rate cut in the coming months, but the Fed's $200 billion in available loans was a huge step to not only lessen the pain of the credit crisis, but it could also serve to take the pressure off the Fed to lower the interest rate dramatically, as it's clear the Fed is willing to take action as needed beyond adjusting the interest rate.
If this level of cutting is inevitable, it will likely be spread out over the next four months, so I think we have at least a few weeks to garner short-side profits in the banks before the Fed meets again.
What is a Short Stock or Option Position?
Did you know there are several ways you can go short? Well, if you didn't you're not alone. I'll help you count the ways to go short.
Do you think a stock is about to go up? You can buy call options or sell put options, as both indicate that you're making a bullish bet. But how you get from Point A to B is quite different.
Live Well, Thanks to Dying Companies
If you don't want to buy a company's products or services, you shouldn't buy its stocks.
What to Know When Making a Short Trade
Do you know what the trading issues are when shorting a stock? Don't get blindsided with shorting.
Going long, buying puts, selling shorts -- all of these can be confusing at first. But there's hope!
