Dear Fellow Big Money Options Traders,
Ask anyone who reads the news: No one is confident about the future. From amateurs to pros, people do not want to own stocks. We live in a time of great uncertainty. We all went over the cliff in 2008. We all remember that feeling. Unfortunately, we all can feel it again. It is Crisis Time.
It may not be as bad as it feels. For those who would like to skip the review of how the crisis has been playing out for the past week, you can jump down to the section labeled “Cheap and Oversold” below.
During times of financial crisis, money flees risk assets and runs to the relative safety of U.S. Treasurys, even if they’re paying zero interest. Asset protection strategies involving diversification among risk assets fail as correlations between all risk assets converge toward one. Normal capital flows dry up as counterparty risk becomes elevated. Those without huge cash reserves are at risk of failure.
Hold on, because it could get worse before it gets better. If German Chancellor Angela Merkel’s statement that the breakup of the eurozone will “never happen” is true, then Germany will have to take strong action fast because words no longer are enough. The private sector is making clear that risk now is too elevated and it no longer will provide capital. For institutions in need of capital, the only capital provider is quickly becoming the lender of last resort — government.
The broad market has dropped by roughly 8% in seven straight trading sessions. The market fell by about 4.7% during the three-and-a-half trading days of Thanksgiving week, which was the worst percentage performance by stocks in the United States since 1932.
The supercommittee accomplished nothing. Germany remains opposed to bonds issued jointly by the eurozone countries. Italian 10-year yields are back above 7%, a threshold level that is considered destabilizing. Spanish 10-year yields are rocketing higher and fast approaching the 7% mark.
Italy 10-Year Bond Yield: 1-Year Chart
Spain 10-Year Bond Yield: 1-Year Chart
Interbank lending in Europe is drying up. Germany was unable to sell its planned 6 billion euros of 10-year debt last Wednesday due to lack of demand and withdrew nearly half of the offering. Standard & Poor’s downgraded Belgium’s credit standing to AA from AA+, and the debt ratings of Portugal and Hungary are junk now.
The declining prospects of the eurozone are depicted by the value of the euro. Shown below is a graph of the CurrencyShares Euro Trust ETF (FXE).
Money is flowing out of Europe and rushing into “safe-haven” investments, which currently are U.S. Treasurys. Shown below is the chart of the iShares Trust Barclays 20-Year Treasury Bond ETF (TLT).
The one positive of Crisis Time is that the bluff is being called. Either Europe does what’s necessary to pull together now or the eurozone breaks up and we eventually put this chapter behind us.
Markets are moving faster than the policymakers in Europe. It appears that the policymakers are becoming more sensitive to this reality and attempting to accelerate their response. The Wall Street Journal reported over the weekend that the eurozone countries are considering forming bilateral agreements that would allow the European Central Bank to take stronger action to stabilize the European bond markets. This morning, it appears that part of the bilateral agreements is the right to reject national budgets that breach European Union rules. The pact should be announced before the Dec. 9 EU summit meeting.
Today, President Barack Obama meets with European officials to discuss the debt crisis. Italy and Belgium will auction loans Tuesday. EU finance ministers will meet Wednesday. Spain and France will auction bonds Thursday. By the end of the day Thursday, we should have a good indication of just how troubled the sovereign debt markets are in Europe.
In the Balance
From a stock market perspective, Crisis Time usually places a tremendous premium on fear over valuation. There is no question that a breakup of the eurozone has many known and unknown disastrous near-term consequences that are worthy of fear. But, it’s very difficult to predict whether the eurozone will break up at all.
Over the long holiday weekend, most Americans weren’t thinking about Europe’s problems as they spent a record $11.4 billion at retail stores and malls on Black Friday, up about 6.6% year-over-year. According to IBM’s survey of 500 online retailers, online shopping was up 24.3% year-over-year. If investors believe that the eurozone will find lasting solutions as they did at the beginning of October, then it’s quite possible that we’ll have a powerful Santa Claus rally.
On Friday, we’ll see November non-farm payrolls. Expectations are for the total payrolls number to rise by about 115,000 and a private-sector increase of 135,000. As we have pointed out before, jobs and housing appear to have found their lows and are moving in the right direction.
Cheap and Oversold
The S&P 500 (SPX) is trading at about 12-times this year’s expected $95 in earnings. About 6% of stocks were trading above their 10-day moving average as of the market close Friday. The market is inexpensive and short-term oversold.
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Please mark your calendar and plan to join us live next Monday, Dec. 5 at 5 p.m. ET. You can sign up via the blue button on our homepage.
REVIEW OF TRADES/POSITIONS
The full details of each trade are shown on the Big Money Options website.
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Top Trades Now
American Axle (AXL) — On Nov. 16, we recommended you “buy to open” the AXL Jan 11 Calls (AXL120121C00011000) for 35 cents or less. At market close on Friday, this position was 10 cents. We still like it up to our recommended limit price.
Applied Micro Circuits Corp. (AMCC) — On Nov. 8, we recommended you “buy to open” the AMCC Feb 7.50 Calls (AMCC120218C00007500) for $1.05 or less. This position was 45 cents at market close on Friday. We recommend this trade up to our limit price.
Corning (GLW) — On Nov. 15, we recommended you “buy to open” the GLW May 15 Calls (GLW120519C00015000) for $2.30 or less. At market close on Friday, this position was $1.34. We still like it up to our recommended limit price.
Harmonic (HLIT) — On Nov. 11, we recommended you either “buy to open” the HLIT Apr 7.50 Calls (HLIT120421C00007500) for 30 cents or less — OR — open a combo by “buying to open” the HLIT Apr 7.50 Calls (HLIT120421C00007500) for 30 cents or less, and simultaneously “selling to open” the HLIT Jan 5 Puts (HLIT120121P00005000) for 30 cents or more, for a net zero debit. (Please note that we bought April calls and sold January puts.) At market close on Friday, the HLIT April 7.50 calls were 10 cents, and the combo could be opened for a net credit of 45 cents. We recommend these trades up to our price limits.
NXP Semiconductors (NXPI) — On Nov. 2, we recommended you “buy to open” the NXPI Jan 17.50 Calls (NXPI120121C00017500) for $2.30 or less. At market close on Friday, this position was 85 cents. We like this trade up to our limit price.
ON Semiconductor (ONNN) — On Nov. 11, we recommended you “buy to open” the ONNN Jan 9 Calls (ONNN120121C00009000) for 40 cents or less. At market close on Friday, the position was 20 cents. We still like this trade up to our limit price.
The remaining open trades are:
Amkor Technology Inc. (AMKR) — On Sept. 16, we were put AMKR stock at $6, plus 1 cent for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the AMKR Dec 5 Calls(AMKR111217C00005000) for 40 cents or more in a 1:1 ratio against the stock you own. As of the market close on Friday, you could get 5 cents for this option. Do not open this position unless you own the stock and can sell the option for at least our limit price.
Celestica (CLS) — On Sept. 15, we recommended you “buy to open” the CLS Mar 10 Calls (CLS120317C00010000) for 60 cents or less. At Friday’s market close, this position was 47 cents. We still like this position, but because it has aged a bit, we’d rather put fresh money into our newer trades (see Top Trades Now).
Chemtura (CHMT) — On Oct. 18, we recommended you “buy to open” the CHMT Dec 12.50 Calls (CHMT111217C00012500) for 90 cents or less. At market close on Friday, this position was 15 cents. We still like this position, but because it has aged a bit, we’d rather put fresh money into our newer trades (see Top Trades Now).
Leggett & Platt (LEG) — On Sept. 16, we were put LEG stock at $22.50, plus 5 cents for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the LEG Dec 22.50 Calls(LEG111217C00022500) for 85 cents or more in a 1:1 ratio against the stock you own. As of Friday’s market close, this short position offered 15 cents. If you already own the stock but are not in the option, sell the stock with it near our cost basis. If you are in the stock and the option, do not take any action. We’re waiting through the expiration period. If you aren’t already involved in this trade, do not open a position.
SBA Communications (SBAC) — On Sept. 16, we were put SBAC stock at $40, plus 3 cents for the cost of the original combo trade. On Sept. 19, we recommended you “sell to open” the SBAC Dec 40 Calls(SBAC111217C00040000) for $1.20 or more in a 1:1 ratio against the stock you own. The company reported earnings a few weeks ago. The stock has almost fully recovered, and we would like to see our stock called away in December.
Telefonica (TEF) — On June 27, we recommended you either go long by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000) for 95 cents or less — OR — open a bullish combo by “buying to open” the TEF Dec 25 Calls (TEF111217C00025000) for 95 cents or less, and simultaneously “selling to open” the TEF Dec 20 Puts (TEF111217P00020000) for 80 cents or more, for a net debit of 15 cents or less. At market close on Friday, the long TEF Dec 25 Calls were 5 cents, and the combo offered a $3 credit to open. However, we don’t recommend adding new money given that the signal has aged considerably. Continue to hold.
Tellabs (TLAB) — On April 29, we recommended you “buy to open” the TLAB Jan 2012 5 Calls (TLAB120121C00005000) for 65 cents or less. At market close on Friday, the position was 5 cents. The company has about $3.50 per share in cash, which should limit further downside. Hold; don’t add fresh money.
USEC Inc. (USU) — On Nov. 16, 2010, we recommended a bullish risk-reversal on USU by “buying to open” the USU Jan 2012 7.50 Calls (USU120121C00007500) for 70 cents or less, and simultaneously “selling to open” the USU Jan 2012 5 Puts (USU120121P00005000) for 95 cents or more, for a net credit of 25 cents or more. We entered the trade for a 30-cent credit. At market close on Friday, the calls were 5 cents, and the puts were $3.80. With the stock trading below our put strike, we don’t recommend adding new money to this trade.
Parting Shot: Maybe Europe Has Too Many Banks
Ireland went bankrupt in 2009. The government nationalized almost all of the country’s banks that year. Then, it implemented severe austerity measures and received bailout funds from the IMF, EU and ECB. Ireland now is showing about 1% GDP growth and slowly paying off the bailout loans.
In hindsight, it appears that rather than nationalize the banks and have the taxpayers pick up the bill for financial irresponsibility, the Irish banks could have been left to fail. Irish banking needs have been handled well by banks in Frankfurt and other places outside of Ireland.
Europe’s retail banking is handled generally by national banks. This would be somewhat like the citizens in the United States banking only with their state banks (e.g., Bank of California, Bank of Georgia, etc.) rather than with Bank of America, Citigroup, Wells Fargo, Charles Schwab, etc. Small national banks often tend to have limited financial resources and a higher cost of capital. In short, they are more likely to fail during times of crisis, and they don’t offer the consumer services that would be missed if they didn’t exist.
For the eurozone to remain a united eurozone entity, European governments and citizens must trade some of their heritage and identity for the advancement of financial unity. Just as people in Kansas use New York-based Citigroup, Greeks may have to bank with German banks. Although Texans take comfort in feeling Texan, they abide by the laws made in Washington, D.C. Italians should continue to be able to enjoy their expressiveness, but they may have to accept being financially bound by more rigorous Germanic standards.
If nothing else, we’re watching world history unfold at a very active time. It’s somewhat akin to watching the ground move during an earthquake. When it’s over, let’s hope the damage isn’t too severe and that we’re in a position to build a better future.
Have a great week trading,
Nick Atkeson and Andrew Houghton
Big Money Options
Dear Fellow Big Money Options Traders,