Bailout Bustup - Covered Call Alternatives
September 26th, 2008 by John BrasherUPDATE - 10:50 am - Thankfully, the historic selloff predicted this morning by NYSE floor traders has not materialized, though the day isn’t over. I think President Bush’s address at 9:35 am helped, and the market seems to believe the bailout will happen over the oppostion of the House Republican Leadership and Main Street itself, which clearly does not understand either the magnitude of the problem or the bailout provisions.
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Treasury Secretary Paulsen hammered together a pretty good bailout plan in which Main Street will buy the bad mortgages - and benefit by the ones that pay. Warren Buffett says that 75% of the subprimes and Alt-A mortgages will pay. Not a bad deal.
Last night the House Republican leadership announced they will not support the bailout, demanding that the bailout be recast as a plan to insure the mortgages. How stupid. You don’t insure something after it goes toes up. Besides, Paulsen’s plan has an upside; taxpayers could conceivably come out not badly at all. The House Republican plan would mean 1) vastly greater cost to Main Street, and 2) mortgagees and mortgage lenders would have no incentive to minimize losses, since the insurance would provide a net. Maybe Congressmen should have to pass an economics test before being seated.
So - stock index futures are down today. The market, expecting a bailout, rallied a bit this week. Well, that’s about to change. Expect a horrible day today in the neighborhood. The selloff could continue into next week. NYSE floor traders were in tears this morning. They believe we will see history made today.
Forget technicals - this is bigger than technicals.
If the market tanks as expected, close the short calls. Beware of rolling the calls down, however, since some kind of bailout will occur soon - who knows what it will look like, or when it passes? You could become trapped in a strike below your basis. Only roll down IF the roll will result in a profitable trade if called. Our trade management calculator will calculate this for you automatically.
If really concerned about another Black Monday-type selloff, close the position.
Other alternatives:
1) Ideally, we would sell the stock and buy back the calls after the stock falls, but this would leave the short calls naked. Consider buying a higher-strike call (this turns the short call into a bear call spread), which will free the stock to be sold - IF you have spread-writing approval.
2) Create an OTM bear call spread (separate from the open covered call position), and close it profitably if the stock tanks.
3) Buy a long-term put and turn the CC position into a SuperPut. Puts might be, ahem, expensive today - even the long-term puts.
Stay frosty, and don’t panic. This, too, shall pass.
September 27th, 2008 at 12:00 pm
So are you saying there will be another Black Monday - On Sep. 29, 2008.
I just saw this blog on Friday night and did not get out of my positions on FNM - Fannie Mae.
If the bailout does not occur by Sunday night are you saying to get out of all call positions and out of all stock positions.
I have a position in Fannie Mae where I bought stock at $2.20 and then at $2.50 when it had gone to $2.90. At the time I sold the calls they were paying a 30% premium.
I bought back the calls when stock went to $1.7. I ended up making 10% on calls but I am down on the stock.
I was thinking with the bailout FNM was still pretty safe. I would either resell the calls as it went up again or leg into the call.
Should I just get out?
September 28th, 2008 at 10:02 am
Marcos, I am not saying that any day will be another Black Monday, but that investors and traders both should be aware that the potential for huge volatility exists right now. The market did not collapse on Friday 9/26 because the market made a reasoned judgment that the Republicans were grandstanding (the Dems have enough votes to push it through, anyway) and that a deal would be reached SOON. At some point, if the bailout does not materialize, panic will ensue and the market make a serious swoon.
We can’t give advice on trades, but I personally would not touch Fannie or Freddie as a CC play under any circumstances. Since no bailout plan has been finalized, I have no confidence that stock in them is safe by any standard of measurement. I only write covered calls on stocks that I deem conservative. Stocks in failed companies that are propped up only by shareholder bailout (assuming they actually will be propped up) don’t meet my test. Thus my only advice to you on these trades is this: don’t put money into them that you can’t afford to lose.
Fannie and Freddie may benefit enormously from finalization of a bailout (or might not), which is why speculators are all over these stocks. These stocks are inconstant right now, because speculators are inconstant. I think these stocks can - rationally - only be approached as speculative plays (”sucker” plays in Cramer’s words). There may be other shoes yet to drop on F&F.