Profit from Someone Else's Margin Call
By Jeff Clark
March 04 , 2008
Just like a first kiss, a first car, or the first time sitting in box seats at a baseball game... traders never forget their first margin call.
For me, it happened just after Christmas, 1984. I was riding into the New Year's holiday on the wheels of a wildly successful 1984. Nearly all of my trades were working out. And the more leverage I employed, the larger my brokerage account grew. So I did the only thing that made any sense... I filled my brokerage account with a large number of complex option positions that gave me 15 to 20 times the leverage of owning stocks outright.
I wasn't worried about the potential downside. After all, I was using leverage on high-quality, blue-chip stocks in the midst of a raging bull market. What could go wrong?
Of course, you can probably guess how this story ends. The first five trading days of 1985 were negative. All of my high-quality, blue-chip stocks were down 2%-3%, and my aggressive use of leverage was hemorrhaging my account.
The brokerage firm insisted I either come up with more money to back up the trades, or I start selling the positions immediately.
Selling was the stupidest thing I could possibly do at the time, but I was out of cash and had no other choice. As I was on the phone entering all of my sell orders, I kept thinking about how I would so much like to be the one buying these trades. That's what I remember most.
Whoever took those positions off my hands did quite well over the next two weeks as the market bolted 6% higher.
Today, many mortgage companies are facing margin calls just as I was in back in 1985. They used enormous amounts of leverage to buy high-quality assets. But, as those assets have fallen in value, their lenders are requiring them to either come up with cash to back the trades or to start selling the mortgages at fire-sale prices.
Whoever is on the buy side of those trades is going to make a ton of money.
All of the headlines right now are focused on those lenders who are being forced to liquidate. What investors ought to be looking for instead are those lenders who are flush with cash and are snapping up high-quality assets from the likes of Northern Trust and Thornburg Mortgage.
Companies like Annaly Capital (NLY) are thriving. Annaly's what we like to call a "virtual bank." The company uses debt only sparingly, so it's not vulnerable to a margin call. The stock pays a 6.6% dividend. And it's currently buying high-quality mortgages from distressed sellers.
While the credit crunch is wreaking havoc on overly leveraged mortgage companies, the more conservatively managed firms are positioning themselves for years of high double-digit rates of growth. Investors should, too.
Best regards and good trading,
Jeff Clark
