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ResearchLover (74.18)

CAPS Play on the Volatile Financial Sector

Recs

4

July 23, 2008 – Comments (5) | RELATED TICKERS: UYG , SKF , WPS

If the overall US market looks rosy till Friday, I think we'll see a reversal in financials then, when investors take their money off the table. 

I'm not this much of a risk taker IRL, but it looks like arbitrage by being both short and long in financials, and just closing positions when they're up, would be the way to make a killing and be just as safe as keeping money off the table in these volatile times, with sentiment being exactly the mixture of what's being expressed (short term bottom, long term uncertainty).  I think the real fundamentals that will move financials is the end of the worst phase of the credit crunch, which will be signaled by housing sales volume increase, mortgage volume increase, and foreclosure decrease for 2 straight months.  That puts the earliest bottom in September.

Of course, if this is what is going on, we could look at the ratio of out of the money September XLF (US Financial SPDR) puts to in the money contracts.  This gives a ratio of 1.58.  It's lower (1.38, without 91,000 way out of the money put 11s.  The ratio for calls is 3.04.  If sentiment were really mixed, the two ratios should be the same.  But instead, they are reading that bulls outnumber bears about 2:1.  The ratios for UYG (double long financials) options are 0.42 and 1.66 (~4:1).

And if I look at the ratios for UYG volume today, the out-to-in-the-money ratios are exaggerated for the puts 0.21, and for the calls 6.18 (30:1 bulls:bears). 

I think this is a short-sighted indicator that momentum is favoring bulls, and by market physics, what goes up unreasonably, must come back down.

If you agree (or not), I would be interested in what positions you would take to arbitrage (or play one side).  I can see housing moving in tandem with the sector, for example.  My strategy has been to be long on financials, particularly european banks and "feddie pae", but to also be long on SKF.

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Long until open on Friday / short until Mid-Sept: FNM, FRE, BCS, RBS, XLF, UYG
Long until drop: SKF
Short until Mid-Sept: PHM, LEN, WPS (Real Estate ex US; interest rate hikes outside the US means that fewer mortgages will close in coming months, squeezing real estate prices outside the US)

5 Comments – Post Your Own

#1) On July 23, 2008 at 2:59 PM, PhillyGator (99.63) wrote:

Right on. Good blog. I just started employing same macro strategy on CAPS. I got in on a dozen or so at the low, I jumped yesterday (too early) to thumbs down a dozen others. Being that its unlikely a sustained growth in Financials for at least a few more months, I think this strategy is sound. Sell when you're in the money. As to real life, I'm interested in others ideas you requested above. I don't trade with options yet so would like to focus on what a little guy can do on the basic. Perhaps just XLF and SKF- anybody use that strategy? You probably don't get the bang for your buck with that?

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#2) On July 23, 2008 at 3:39 PM, ResearchLover (74.18) wrote:

Middleton (ETF commentator on MSN) says play the financials by buying SKF, and keep a big cash position right now.  The thing with tracking stocks to be aware of is if they track a 10% decrease in the sector, and then a 10% increase while you hold them, you're only back up to 99% of your principal.  Whereas with options, volatility increases their value.

But time decreases their value all the same.  Which is why with either of these vehicles, IMO a medium term (3-6 month) strategy should probably be considered.  I'm steering clear of options trading IRL, but yahoo will give you all the stats on current days trading and open positions, which can be used as a "market myopia" indicator in cases like that demonstrated above.  That's the real value of options for the average investor--to be aware of how they work, and look at what options players as a community are thinking.

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#3) On July 23, 2008 at 4:05 PM, PhillyGator (99.63) wrote:

Interesting, I signed you up as a favorite- keep reading ur blogs. BTW, what is IRL and IMO (don't laugh). Trying to figure out how to read these options on Yahoo.

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#4) On July 23, 2008 at 7:10 PM, zygnoda (24.35) wrote:

in my opinion   and  in real life  

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#5) On July 24, 2008 at 1:51 AM, ResearchLover (74.18) wrote:

To read the call and put activity on any stock on quote.yahoo.com, quote a symbol and under "more on [symbol]" click options.  I had to calculate those ratios in excel, given the current stock price to specify in and out of money positions.

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