Sunday August 12, 2007

Greetings Trade Makers, Play Stakers and Money Rakers,

If you like wild rides that dump a load of cash into your options account you gotta love the action from last week—

THE BOTTOM FELL OUT OF BED BATH AND BEYOND ROCKETING OUR AUG 35 PUTS TO AN OUTRAGEOUS ONE-HUNDRED-SEVENTEEN PERCENT PROFIT!

PLUS DAIMLER-BENZ—TICKER DAI, FORMERLY DCX—PLUNGED BELOW OUR EXIT TRIGGER THURSDAY FOR A QUICK THIRTY-THREE PERCENT GAIN!

In addition we’ve got open plays destined to rack up some nice profits as well. We did get stopped out of Lennar (LEN) this past week for a tiny loss but the opportunity in the housing sector isn’t over yet—stay tuned.

In the meantime the market pundits have been howling and the Fed has held their finger down on the digital printing press for 48 hours straight—so is the worst behind us or are there more fireworks ahead? To find out let’s take a good look at…

WHICH WAY THIS MARKET IS HEADED

As you can see the markets look like the emotional gyrations of manic depressive on crack—not exactly a reassuring image. The popular index we’re not showing is the Dow which was down over 200 points on Friday before managing to close the session only 31 down after Thursday’s massive 387 point plunge. The point is the Dow is right in there with the rest of the exploding indices.

The spreading of the subprime mortgage panic to credit markets, hedge funds and other financial institutions led to big gyrations this past week, including rallies through Wednesday followed by an Acapulco style cliff-dive on Thursday.

The action was scary enough to get the Fed and other central bankers injecting big cash into the global financial system on Thursday and Friday in amounts not seen since after the attacks of September 11, 2001.

Central banks in Europe, Asia and the U.S. injected billions of dollars into banking systems Friday, moving to further boost available cash in markets suffering the ripple effect of the subprime-credit crisis. The banks made sure to announce there was more cheap money where that came from if it’s needed.

The Fed said it will provide reserves "as necessary" to promote trading in the federal funds market at rates close to 5.25%, the base rate.  Other central banks made similar pledges about being willing to lend more.

The problem is overnight rates at which banks lend money to each other rose again Friday, with the dollar-denominated rate hitting 5.96% from 5.86% the previous day, according to data from the British Bankers' Association. That means rates are still rising in spite of the central bankers action because no matter what the central banks do investors still rightly perceive a truckload of risk in buying mortgage backed securities—or any other murky debt instruments for that matter.

Investors are trying to game the amount of risk out there right now and the high degree of uncertainty means mortgage rates are rising along with qualification standards making home loans increasingly difficult to get---especially on ‘jumbo loans’.

The average rate on a 30-year fixed-rate conforming loan -- conforming loans are for less than $417,000 – came in last week at 6.66% while the average rate on jumbo loans rose to 7.35% last week according to Bankrate's survey of 100 banks, pushing the spread between the two rates to 69 basis points, up from 28 basis points in just two weeks.

That means the higher end of the housing market is going to start taking the same shellacking the entry level market has been taking since banks started enforcing stricter qualification standards a few months back.

The real estate sector has been hurting but as rates rise and loans get harder to fund it’s liable to get worse. Homebuilder stocks took another hit on July 26 after a fresh batch of poor quarterly financial results and new economic data reinforced investors’ concerns about a deepening slump in the U.S. housing market.

Sales of new homes fell 6.6% in June to an annualized rate of 834,000, after a revised 2.2% decline in May to 893,000. The drop was more than three times what was expected and the biggest decrease since January.

Inventory was unchanged from May at 537,000 units, which represents a supply of 7.8 months. The median price of a new home continued to fall to $237,000 from $241,000 the previous month.

The data followed a July 25 report showing that existing home sales fell 3.8% in June to an adjusted annual rate of 5.75 million, lower than expected. This sparked worry that housing would take much longer to recover than investors had anticipated.

In spite of some disastrous fundamentals the housing sector got a boost and short-sellers scrambled this past Wednesday on positive mortgage-application data. The Mortgage Bankers Association's weekly mortgage applications index rose 8.1% last week which is the largest weekly increase since January. The problem is an increase in mortgage applications won’t necessarily be translating to new home sales as both interest rates and qualification standards continue to frustrate potential home buyers.

Meanwhile the markets are pinning big hopes on a Fed rate decrease at their next FOMC meeting in September--but based on the Fed’s language at their meeting this past week that may be a misguided hope. 

At their most recent meeting the Fed repeated its statement from June that "a sustained moderation in inflation pressures has yet to be convincingly demonstrated." It warned the risk that inflation will fail to moderate was its "predominant policy concern." Those inflationary concerns were likely heightened on Friday when government data showed prices of goods imported into the U.S. climbed 1.5% in July, led by a big increase for petroleum. The report marked the sixth straight monthly increase in import prices.  The Labor Department's data follow a revised 0.9% gain in June. July's increase, the largest since March, suggests more inflationary pressure from abroad as the dollar continues to slide.

So the central banks are trying once again to flood the markets with cash and at the same time contain inflationary pressures, while the mortgage and housing sectors continue to crumble. The markets are pinning big hopes on the Fed to bail out the financial sector but the Fed’s hands could be tied by an ever-upward spiraling inflation cycle and a falling dollar—the question is…

HOW DO WE MAKE MONEY ON IT?

If ever there was a market that screamed for strangles this has to be it—you’re liable to make a fortune in both directions as the markets careen from suicidal to hysterically giddy. The key is to pick a stock with massive potential in both directions and we’ve found the perfect candidate.

Our ‘both directions’ play is a mortgage and banking stock that by all rights should plunge through the floor—but at the slightest hint the Fed might loosen this stock could just as easily gap to the moon. Either way we’re likely to make money on both positions just by buying out to September as the moves we need could happen within days. The options are priced right and this horse is ready to run so we’ll be mounting up first thing Monday morning.

Our second play is on a stock in the home building sector that is particularly vulnerable to a downturn in the coming weeks and fortunately for us it’s blasted higher enough on the thin mortgage news to make our target puts especially attractive.

We’ve got two great plays lined up on a market that is anything but tame so let’s get going…