Reasonably Thinking

Calculated Risk summarizes a WSJ article on housing.  The post is very informative and brief.  Here is a preview.

Although there are markets where there is just too much supply (like Detroit), in most markets the problem is too much supply at the current price. So falling prices will help clear the market.

http://www.calculatedriskblog.com/2010/07/wsj-housing-market-stumbles.html

http://online.wsj.com/public/resources/documents/HagertyQuarterly.html

The three big banks, JPMorgan Chase JPM, Bank of America BAC, and Citigroup C, reported quarterly earnings late this week.  On the surface, earnings seemed acceptable, yet revenue disappointed.  This implied gains from cutting costs–not expanding the core business–something the market did not take favorably.  This influence, combined with unhappy earnings from Google GOOG and poor consumer sentiment, sent the market falling today.

(Image from MarketWatch)

As a result, the FAS bull market exchange traded fund sunk 12.2%.  With the decline, I was happy to take profits.  I sold my 1 put option, purchased Tuesday, for $11.30, netting me a proft of $210.06.

I still maintain a short position in UYG since I believe the long term trajectory for banks is treacherous.

With options expiration taking place today, I decided to trade out of my Freddie Mac FMCC position and take profits.  Ideally, I would have liked to convert the options into a short position, however the number of shares available to short was unlikely to suffice conversion.  The risk was had I converted, I could have faced an automatic cover at Monday morning’s market price.  Given that FMCC had a twenty-five cent bid-ask spread, this was not a risk I was willing to take.  Twenty-five cents becomes a sizable spread when trading 12 contracts that represent 100 shares each ($0.25 x 12 x 100 = $300).

The trade:  I sold 10 contracts at $0.62 and 2 contracts at $0.61.  These 12 contracts were originally purchased back in February for $0.16 each, netting me a pre-tax profit of $501.77.

To complete my options roll (from Tuesday), I sold my 6 ITB put options today at $6.10 each.  Keeping track of all housing trades (starting February 2009), I have a gain of $928.  Currently, I still own 9 put contracts (green highlights), worth $5,720.  In simpler terms, I have a position currently worth $5.7k betting that the stock prices of homebuilder companies will fall.

For the thesis behind this trade, please read Housing, Economy, Banks–A Three Legged Stool With Three Broken Legs.

Also, an update on the Freddie Mac (FMCC) put options…  After speaking with my broker today, I realized that my best play may be to convert the options into a short position.  The stock has recently been trading between thirty to forty cents per share.  Frankly, I can’t see how anyone on the other side of the trade would be investing; it would be more like gambling.  In my opinion, the equity is worthless.

With option expiration scheduled to take place on Friday, I must be prepared.  Two of my positions that are set to expire are my Freddie Mac (FMCC) puts and housing (ITB) puts, both of which are in the money.  My intent is to exit the Freddie Mac position, since the stock is trading over the counter, and to roll the housing position.  To roll the housing position, I simply need to purchase put options for some time in the future and sell/convert my current puts (that expire Friday).  To initiate this strategy, I purchased 7 ITB put options today, with an expiration of January 2011, for $5.90 each.  I will obviously exit my 6 July ITB puts before the week’s end.

Independent from the above, I decided to increase my short exposure to financial companies.  In the long term, I foresee a subdued economy where bank loan losses increase.  As such, I shorted 25 shares of the financial exchange traded fund UYG at $57.60.  In addition, I believe provisions for loan losses (funds set aside for loan losses) are currently too small; an increase in quarterly provisions could stymie bank profits.  Furthermore, it is possible that European credit concerns throughout the second quarter reduced lending, which could hinder quarterly revenue.  Therefore, I purchased an August put option, with a strike of $32, on the financial bull exchange traded fund FAS for $8.90.

So, the UYG is the bearish long term play; FAS is the bearish short term play.  JPM reports its quarterly earnings on Thursday; BAC and C report their quarterly earnings on Friday.

You can read more about my perspective on housing, banks, and the economy by reading my latest opinion piece:  Housing, Economy, Banks–A Three Legged Stool With Three Broken Legs.