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Weekend Edition
The Best of The S&A Digest
October 25, 2008
 I'd have a bigger audience for my new Put Strategy Report if I were teaching a high-school class instead of writing to one of the largest financial subscriber lists in the world.
I understand the hesitation: People are scared, and selling puts is something most people don't do. And the fact is, I'd normally never recommend selling a put option – ever.
But right now, pricing in options is absolutely insane. No matter how bad things are, stocks will never be worth a negative number. And yet, right now, people are buying insurance on stocks (puts) at prices that assume the stocks will actually go to less than zero.
Meanwhile, no matter how carefully I explain the situation, no matter how clearly the facts are on my side, I can't get anyone to take this advice... by far the most lucrative and safest advice I've ever given in my entire career.
One more thing... We'll make money selling these puts even if the stock market declines. Why? Because this extreme pricing simply can't last. The index that tracks the prices of options is known as the VIX. When the VIX exceeds 50, it is an extreme situation. It has only gone above 50 18 times. (It has never before gone above 80 – like it did recently.) And it never stays so high for long. On average, when the VIX has risen past 50, it falls by 81% over the next month.
So as the panic fades, the opportunity to sell puts at absurd prices will pass. As the prices on our puts fall 50%-80%, we'll be able to buy them back without having to wait until they expire. We'll make a killing in the next few weeks. To learn more about my Put Strategy Report, the best way for you to make money in the markets right now, click here.
When Lehman Brothers still existed, the bank had around $150 billion in debt. And the Securities and Exchange Commission let hedge funds and other investment vehicles take $365 billion of insurance out on that debt through the use of credit default swaps. It was like buying life insurance on someone you knew was going to die soon.
Now the sellers of these swaps are on the hook for $365 billion. And guess who sold most of the Lehman swaps? AIG.
When the history of this debacle is finally written, AIG will be at the center of the story. AIG sold insurance on hundreds of billions of dollars of assets, with almost no collateral. It, along with Fannie and Freddie, was the primary reason so much credit was created and the primary reason so much credit has been destroyed.
Traders are piling into bets that oil will fall to $50. Options contracts to sell 1,000 barrels of oil at $50 a barrel by December jumped 50-fold to $500 since October 3. Goldman Sachs and Merrill Lynch predict crude will probably drop another 44% if we enter a recession.
To stop the freefall – oil is already down more than 50% from its July highs – OPEC cut production. Merrill's head of commodities research, Francisco Blanch, doesn't think OPEC can stop the bleeding. "OPEC is going to try to prevent some of the price decline," he told Bloomberg. "It's going to be very difficult to stem a price fall."
Leon Cooperman of Omega Advisors doesn't believe we've hit bottom. But he thinks we're getting close. Cooperman said 21.2% of all S&P 500 stocks are yielding more than 10-year Treasuries – a historic high. He also said the best evidence the recession is over will come when a company announces bad earnings and its stock holds steady or rises. He hasn't seen it yet.
Whether we're at the bottom or not, governments aren't nearly done "helping out," and that's never good.
The Argentine government is going to give investors some help from which many may never recover. Argentinean President, Cristina Fernandez de Kirchner, wants to take control of $29 billion in privately run Argentine pensions. The Argentine stock market didn't like the news at all. The country's MERVAL stock index fell to a four-year low yesterday, right after the government published reports saying it will take over 10 privately run pension funds – even though other Latin American markets went up.
House Financial Services Committee Chairman Barney Frank wants a "moratorium" on all Wall Street bonuses. "They have a negative incentive effect because they are the ones that say if you take a risk and it pays off you get a big bonus," he said. And if it causes losses "you don't lose anything." The halt on bonuses should last "until they can get a better structure without that perverse incentive," he added.
I agree the incentive is perverse, but that's only because the risk is sloughed off on the clients and shareholders, all of whom are the ultimate source of those big payouts and ought to bear the brunt of the risks they willingly take. If you make a crappy investment, you deserve to lose your money. That's what happens in a market economy. That's how it's supposed to work.
Barney Frank knows he works for a country full of sheep who love handing him their power in exchange for promises of safety and security, promises that could never be kept.
Regards,
S&A Research
Porter Stansberry writes and edits the daily S&A Digest, which comes free with a subscription to one of our premium products.
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