Financials are taking quite a beating these days, not only price-wise, but also in the esteem of stock pickers, dividend investors, the buy-and-hold crowd and pundits alike. And for good reason. The brokers, banks and insurance companies are generally quite suspect. There is no way to know if another shoe (or a bag of shoes) will drop for any one of them.

Bear Stearns was in desperate straits - though well known to the industry - long before we of the public knew. Banks are exposed on subprime, Alt-A mortages, contruction financing on projects that are going to be slooowww sellers. Many large and regional banks, if forced to value assets properly, would have to close their doors. Regulators are looking the other way, and have no choice, in order to give the banks a couple of years to raise capital and outrun their current problems. Insurance companies also have exposure to many of these things. We have a severe information deficit about the financials in general. You and I have no way to know the true extent of these companies’ woes. At this point, I view an investment in most financials the same as diving into an unknown lake - we have no clue where the stumps are, or how many.

As if all this weren’t bad enough, the market has zero tolerance for mystery or goofiness in financials. A financial will sell off on the slightest whiff of negative news - even if not about that company directly and even if not particularly applicable to it. Unless you are intimately familiar with a company, it is healthy and not cutting its dividend, tread carefully. I do have a couple of suggestions below.

While some stocks like Wells Fargo are being touted as recovery plays, I definitely would not go long the stock without SuperPut protection. If truly convinced that a financial has been knocked down to a fire-sale bargain price level, consider instead buying an OTM (cheap) call with an expiration perhaps 3 to 6 months out; or whatever time frame you envision. If the stock recovers as expected, you’ll profit immensely. If it does not, you’re not out much.

Trading Possibilities:
Perhaps it’s one of those fractal things, but every rule has its exceptions, and there are a few good financial stocks. Here are a couple, both of which recently increased the dividend and are not beset by many of the problems afflicting most financials:

Bank of Nova Scotia (BNS) - This Toronto-based megabank operates well over 1,000 branches outside Canada and make a lot of money. It has seriously outperformed its peers and the S&P 500 since 2002. And since 2003, it also has increased revenues, earnings and dividends, with revenues, earnings and dividends expected to continue increasing in the future.

BNS has been falling of late, like most things. It’s no surprise that a financial would have been whacked recently with the market. Technically, the price has touched the 200-MA on a weekly chart and is clinging to the 50-wk average. If if breaks back above the 50-week average (which is also the middle of the Linear Regression channel), it’s a buy.

Banco Santander (STD) - this highly profitable Spanish bank has increased its dividend significantly since 2003, growing revenues and profits as well, and since 2004 has beaten the snot out of both the Large Bank industry and the S&P 500. Technically, it’s at the bottom of its trading channel on both daily and weekly charts…

As Yogi Berra said, you can look it up. Translation: do your own research.

Stock futures are pointing strongly down before the open. The S&P 500, Nasdaq 100 and Dow Jones Industrials all fell this morning, which usually augurs a stock market selloff - just as stock futures strongly up usually mean an up day. This does not mean that the market’s apparent bounce off the bottom of its channel (discussed in my most recent newsletter issue) is invalidated, because an index - like a stock - often needs multiple tests of a support level before it can take off.

Thus if the market does sell off back to the 11,000 level, it is not cause for panic. To the contrary, for the market to find support there again would presage a nice rise back toward the upper channel line.

FINANCIALS:
These are poison for any long stock position until further notice. This goes for all financials - brokers, banks, mortgage-related and insurance. If you assume the other shoe has dropped for Citi and Bank of America, you are gambling. Save it for Vegas. It is not just the subprime, either. Even with my SuperPut strategy (buy a long-term put to protect a covered call position), why buy a stock that poses considerable danger?

HOUSING:
Don’t go there, no matter how tempted by the “bargains” available. The recent “surge” in housing starts was phony, a result of NYC changing its definition of what is considered a housing start. Eliminate that, and housing starts fell.

Today is expiration Friday for the June 2008 equity options (tomorrow, Saturday, is actual expiration day). If you are short ITM options at or close to expiration and do not want to lose the stock, meaning have it called away, here are two techniques that allow you to keep the stock:

1) Buy back the short ITM calls, which will be down to parity (trading at intrinsic value) or close to it. If the stock has advanced, this is an expensive prescription, because the call’s intrinsic value will rise with the stock price. But this is a poor practice, because it adds to the cost basis in the stock. In other words, the stock price will be below the position’s cost basis. The only justification for closing ITM calls is an expectation that the stock will rise in the short term, recouping the cost of buying back the calls. If the stock pulls back, the stock will be below cost basis. Thus closing ITM calls should be reserved for those instances in which you have a short-term bullish outlook on the stock.

As a side note, the market may well have bottomed temporarily, as noted in my most recent issue of the Money Newsletter. If so, good stocks will be rising in the short term. Weigh this alternative with the one below.

2) Roll the calls out to the next month, meaning to buy back the short ITM calls and sell calls of the same strike price for the next expiration month. Because premium will be higher for the next month, rolling up should generate a credit, not a debit. The roll out allows you to neatly skip over assignment this month and defer it. If the assignment is presented again at next month’s expiration, you can roll out again.

You may be able to roll up and out to the next month for a modest debit (I personally don’t add debits unless they are nominal) - or roll up and out two months. In a strong bull market, this may make more sense, because stocks can rise for a long time without a meaningful retracement.

A frequent question I get about rolling out is: isn’t it just deferring the inevitable? Not really. Remember that YOU choose whether you are assigned or not. If we posited that the underlying stock will keep rising forever, then rolling out would indeed only postpone the day of reckoning. But that does not happen. Sooner or later the stock will retrace and give a breathing space to close the short calls. In a volatile or bear market (like the one we have now) a pullback is pretty much assured.

If you roll out, you can always close the new calls - that option always is on the table.