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Ground Control To Sully: We Need You, or Someone Just Like You

January 20, 2009

Dear Fellow Big Money Traders,

Capt. Chesley B. "Sully" Sullenberger III performed a miracle on the Hudson River this past week by landing a jumbo jet on water without major trauma, allowing all 155 passengers to escape safely.

Investors and citizens to Capt. Sully: Would you be so kind as to take the controls of this economy and bring us down gently? It appears we have lost our easy credit and asset inflation engines due to a double greed strike.

Let's hope President Barack Obama maneuvers the U.S. economy in as skillful a manner to allow investors and citizens to survive the ongoing financial crash.

Polling data indicate Obama is to the economy as Sully is to planes without working engines. According to surveys conducted during the weekend:

• 71% of Americans believe the economy will improve during the first year of the Obama presidency.
• 65% believe employment will rise.
• 72% believe the stock market will recover during the next 12 months.
• 63% believe their personal financial situation will improve.

(source: Mail Online, World News, 1/19/09)

Remember, consumer attitudes toward the economy can be a more important indicator of future economic activity than current measures of actual economic activity. We may just re-ignite the economic spending engine with some renewable optimism energy.

Staying Afloat Long Enough to Survive

In a plane crash, the only outcome that truly matters is the survival of the passengers and crew. It seems odd to think of a crash as a "success," but the water landing on the Hudson was an incredible success as it gave time for all passengers to escape before the plane made its final descent below the water.

Like a crippled plane, the country's goal is to give the economy a soft landing and avert disaster. With crises in both planes and economic crashes, each event is different. Much of the time, what is creating the crisis is not covered in the training manuals or simulators.

During this capital crisis, the over-extended financial sector has seen a progressive collapse in collateral values. With collateral values plummeting, equity ratios have been squeezed, putting many of the largest financial companies at risk of complete loss.

Starting with the extraordinary 75-basis-point Fed interest-rate reduction last January, the government has been trying to bring the financial sector down in a controlled manner that will allow for the good portions of the group -- along with the broader economy -- to be saved. On Thursday, the remaining funds from the TARP program received congressional authorization to be spent.

Good Bank, Bad Bank

The past week, Citigroup (C) discussed dividing into a "good" bank composed of profitable assets like its commercial, retail and investment banking businesses and a "bad" bank made up of brokerage, consumer finance and a pool of risky assets.

Bank of America (BAC) received a commitment of another $20 billion government capital injection and support of $120 billion bad bank assets.

Effectively, the government bailout is dividing the entire financial sector into a good bank/bad bank. Banks are carving out their bad bank assets and selling them to the government. What remains in the private sector are the good bank assets.

Ignoring the long-term ramifications of moving the bad bank ownership from the private sector to the taxpayer, it is clear that if you carve off the bad and leave the good, what is left trading in the private sector will one day be profitable, functional and attractive to new investors.

The recent troubles of the S&P financial sector, down more than 16% last week and back at its November lows, are almost entirely a problem of uncertainty about what portion of the banks are bad versus good. Current bank equity- and debt-holders fear their investments may have no residual value.

Floating On Water

With the worry now being how much of the financial sector is rotten rather than a question of whether its core lending function will continue to exist in some form (possibly much of it nationalized), by definition the investment world has improved.

The capital injections and asset guarantees that have taken the financials from a nosedive to a softer landing trajectory may be giving time for broader equity values to survive the financial crash.

The most encouraging sign that the market may have some buoyancy is the S&P 500 (SPX) ended the week more than 10% above its low with the financial sector back at its low. The divergence between the financials and the rest of the market materialized most dramatically on Friday, with the overall market rallying later in the session as the financials continued their descent.

The New Normal

Another way of stating in brief what is said above is to say the CBOE Volatility Index (VIX) appears to have found a new range between 40 and 50, down from the fourth-quarter black-hole levels of 60 to 90.

Investors continue to worry about balancing depressed stock valuations with deteriorating fundamentals, but they are no longer worried that the world is coming to an end. The investment community is gaining confidence that the government will continue to vacuum up the really ugly mess called the "bad bank."

Some might say the light at the end of the tunnel is now faintly visible. The market has finally returned to doing what it does best: setting valuations for going concerns based on their fundamental earnings power.

Again, the world is not coming to an end. It is just a case of establishing equilibrium equity valuations during a time of great economic uncertainty. The speck of light in the distance is that the bulk of the necessary corrective actions have been taken and the bad news is mostly priced in.

The nose of the economy is headed down but not straight down -- and at some point, it may turn up.

Evidence that a new normal has been established is abundant in the options market. Intelligent versus panicked options flow is now the order of the day.

We are seeing many more actionable signals, and trading them accordingly. As always, keep some powder dry for the trades that will be coming to your inbox as they develop!

REVIEW OF OPEN POSITIONS

This past week, we recommended initiating a put position on NBTY Inc. (NTY), a call spread on Canadian Solar (CSIQ) and closing half of the Cracker Barrel Old Country Store (CBRL) put position.

Additionally, four more of the "black-hole" positions -- Stanley Works, Crown Castle, Teradata and Compuware -- closed without value. These four trades were options put on in mid-2008 and were damaged during the fourth-quarter market crash.

Let's take a look at how our newest trades are performing so far:

NBTY Inc. (NTY) -- On Jan. 14, we recommended buying the NTY Feb 15 Puts (NTYNC) for $1.15 or better These puts closed the week at $1.15.

Canadian Solar (CSIQ) -- On Jan. 15, we recommended using a spread order to buy the CSIQ July 5 Calls (GQAGA) for approximately $1.85 and simultaneously sell an equal number of the CSIQ July 10 Calls (GQAGB) for approximately 60 cents, for a net debit of $1.25 or less.

This trade gives us the opportunity to triple our money if CSIQ goes to $10 or higher. Additionally, by using a spread strategy, we were able to buy the $5 strike calls in July for less than what you would pay for the April 5 Calls. This trade closed the week at $1.05.

CBRL Group (CBRL) -- On Dec. 10, we recommended buying the CBRL March 20 Puts (CBQOD) up to $3.50. We closed half the position on Jan. 14 for $4.80 The stock had reached a point of technical support which we expect it will eventually break. However, prudence dictated that we take some money off the table.

Other Open Trades:

Supertex (SUPX) -- On Jan. 6, we recommended selling to open the SUPX March 25 Puts (SQOOE) for $2.75 or more. These puts closed the week at $3.70.

Rackable Systems (RACK) -- On Jan. 8, we recommended you buy the RACK June 5 Calls (RQOFA) for 95 cents or less. These options closed on Friday at 45 cents, as the stock was hurt by a negative earnings preannouncement. We continue to like this trade given the $5.88 per share in cash and no debt.

Shaw Group (SGR) -- On Nov. 26 we recommended selling the April 12.50 Puts (SGRPV) for $2 or more As this option position approaches a greater than 80% return, we will be looking for optimum times to close the position. On Jan. 12, we recommended closing half of this position for 30 cents or better. The option closed the week at 35 cents.

Novellus Systems (NVLS) -- On Jan. 8, we recommended buying the NVLS Feb 15 Calls (NLQBC) for 75 cents or less. This position closed the week at 80 cents and we continue to like this trade.

Wal-Mart Stores (WMT) -- On Jan. 8, we recommended selling the WMT Feb 47.50 Puts (WMTNW) for $1.45 or more. These puts ended the week at 93 cents. We continue to like this trade.

Cadence Design Systems (CDNS) -- On Jan. 9, we recommended buying the CDNS May 5 Calls (CDNEA) for 60 cents or less. This position closed at the end of the week at 45 cents and we continue to like this trade.

Hain Celestial Group (HAIN) -- On Oct. 21, we recommended you buy the HAIN Feb 25 Calls (QQHBE) as part of a bull-call spread for $3.40. HAIN was badly damaged by the market crash. We are hopeful to recover more than the current 10 cents from this position but we do not recommend adding new money to this trade.

CBRL Group (CBRL) -- On Dec. 10, we recommended buying the CBRL March 20 Puts (CBQOD) up to $3.50. These options closed on Friday at $3.50. We continue to like this trade.

Pool Corp. (POOL) -- On Dec. 10, we recommended buying the POOL April 17.50 Puts (QCLPW) for $3.80 or less. These options closed on Friday at $3.20. We continue to like this trade.

MSCI Inc. (MXB) -- On Dec. 11, we recommended you buy the MXB March 15 Puts (MXBOC) up to $2.50. These puts closed the week at $1.25. With the financial sector melting down, we wonder how much longer MXB will defy the trend. We continue to like this trade.

Vasco Data Security International (VDSI) -- On Nov. 4, we recommended buying the VDSI March 15 Calls (QFNCC) for 95 cents or better. This position closed the week at 10 cents.

Unfortunately, the company had a negative earnings pre-announcement that halted the positive upward trend the stock was in the process of establishing. Although the stock has pulled back, the original signal is still valid and we are staying with the trade. However, we would not add new money to this position.

PowerShares WilderHill Clean Energy ETF (PBW) -- On Oct. 9, we recommended buying the PBW March 10 Calls (PBWCJ) up to $2.45. These options closed the week at 35 cents. The initial option signal continues to be there, so we are staying with the trade.

PARTING SHOT

On Friday, Obama called Capt. Sully to say what a "heroic and graceful job he had done in landing the damaged aircraft." He also invited Capt. Sully and his crew to attend the inauguration.

We suspect Capt. Sully may be thinking he is honored but that he was just doing his job. He might also be thinking how proud he would be of President Obama if he also did his job and pulled off a heroic and graceful soft landing for our damaged economy.

May the honeymoon in Washington, D.C., begin. With the good vibe coming from the swamp, we may see a further return to the new normal. Normal is good, as it will lead to happy options returns.

Have a great week and a great year trading.

Nick Atkeson and Andrew Houghton

Editors

Options Trader