Profit Opportunity #1

[RightSide]

Since we are almost about 3 months since I shorted LEND, I thought I would check in here…I’m glad to see that some other people have also made this trade.

As I stated in my original post, this is a fundamentally driven position trade. My outlook on LEND has not changed and I think the possability for LEND to go ZERO is still very high. I’m looking to add more short exposure to the whole crumbling housing market thesis.

I’m trying to find out which of the overleveraged homebuilders are going to go down the toilet as well…Standard Pacific looks like they might be facing a serious cash crunch in the near future…though their financial engineering makes it difficult to identify their exposure to a depreciating market.

I see poway is thinking of shorting WAMU, and as much as I hate to be on her side of the trade, I think it is probably a good short too…anecodatly they are about to move into a big shiny new hirise in Seattle…which has sometimes marked a company’s top…(remember timewarner buying AOL and moving into their big new billion dollar office space in 2000?)

[powayseller]

Hey Rightside, before I even read your post, I had decided to congratulate you on your LEND decision. You definitely turned out to be right. So this congratulation has nothing to do with your agreement with me on WM. Eric Janszen from iTulip told me he’s torn between shorting WaMu and Wells Fargo, but hadn’t studied the financial statements yet for a final decision.

[barnaby33]

What pisses me off is I tried to short LEND and TDWaterhouse, my broker wouldn’t do it. They don’t let you short most stocks and if you want to its a massive PITA.

Josh

[Anonymous]

I’m thinking about shorting more LEND soon, I think the timing is right for the subprime lenders to fall hard. I already covered my LEND shorts a couple weeks ago to lock in those gains but I know there is a lot further to go. NEW is also starting to look very attractive as short candidate, the downward momentum is starting to pick up.

Josh, you need to change brokers man, don’t know whey they won’t let you short LEND. I recommend Fidelity, GREAT Service, great web site, 24 hour phone assistance, etc. Plus with a broker that big they always have plenty of shares in their system to short.

[waiting hawk]

I would watch out. I heard Wells Fargo was Late in the game on ARMS

My website tracking Temecula and South Riverside County

[rocketman]

Why short LEND when there’s better money to be made in other places. The market is going to rally this fall and who wants to see their profits go up and down till Spring? It’s best to wait till you see the Fed increase another 1/4 point before you short this one. The damage has already been done. Your too late.

[rseiser]

barnaby,
I don’t quite understand what you mean with shorting using TDAmeritrade. One time you mentioned that it was difficult, the other time you mention “short LEND and TDWaterhouse”. I am short all kinds of stocks in my TDWaterhouse acount, and it works very well. I never have to call them. I was even able to short rare stocks like “CLM” (not for the faint of heart). The only problem I found is that when shorting I don’t get credited the dollar amount versus my stocks on margin. So I still have to pay margin interest for some of my longs, and don’t get any interest for my shorts. This makes me tend to use in the money puts, that have another advantage for the small investor that premiums are automatically deducted from your profits, so your tax is reduced without itemizing.
I read that most retail-brokers don’t credit the short-balance against your margin (or pay interest). This puts you in a hole by 5% annually versus the professional. Does anyone know a broker that would credit the short-balance?

[lewman]

Rseiser,

You wrote:

The only problem I found is that when shorting I don’t get credited the dollar amount versus my stocks on margin. So I still have to pay margin interest for some of my longs, and don’t get any interest for my shorts.

I thought that when shorting a stock, I borrow stock and sell it. But the “borrowing” incurs expenses and the expenses are covered from the interest generated by the cash from the sale of the stock. Am I wrong ? Do correct me if I’m wrong.

You also said:

This makes me tend to use in the money puts, that have another advantage for the small investor that premiums are automatically deducted from your profits, so your tax is reduced without itemizing.

Could you elaborate on this ? Thanks.

[rseiser]

leung, yes, that is what the broker generally wants to tell you, i.e. that you have to pay interest to borrow stock, and get interest from the cash raised, and that they cancel each other, and therefore you get nothing. I don’t believe this is true, since LTCM did it (“no hair-cut”), and I read that if you are a good client then you would have these better conditions (i.e. getting cash credited and not pay for borrowing stock). Also, quite frankly, who would get paid interest if your broker lends your MRK stock to some guy for short-selling? You don’t get anything, you only get the dividends, and when you sell your stock, you get the proceeds. So, on lending your MRK stock to a short-seller, the broker charges him the self-proclaimed “interest”. The broker doesn’t really deserve this interest, but it is a free-bee for him. I heard they are making good money from this.

Part two:
In-the-money puts have larger intrinsic values, i.e. the difference between strike price of the option and market price of the stock. They have nearly zero risk premiums since they are likely to end in-the-money as well. They do have, however, something I call “dividend premiums”, and (in the case of calls, mostly) “interest premiums”, since you are spared these extra expenses as opposed to shorting. Let’s take a random example: WM jan2008 $45 put. It currently trades at $5.80 and the stock is $41.90. Assuming these quotes are correct, I estimate that the option price (per share) is roughly composed of:
$3.10 intrinsic value,
$2.30 dividend (est. for the next 5 quarters)
$0.40 risk premium (for the risk of the stock rising above $45)
This seems like a better deal than shorting WM. When you short it, you have infinite risk, you have to pay the dividend, and you kind of have to pony up some cash to fund you margin account that you could otherwise use elsewhere.
With the option, your risk is only $5.80 (even if the stock goes up to $60), and that is all you have to send in to your broker. Assuming the stock doesn’t come your way and stays at $41.90 by Jan 2008, your option would be worth $3.10, and you lost $2.70 per share ($5.80-$3.10), so $270 for a contract of 100 shares. This $270 loss is a short-term capital loss subtracted from your short-term capital gains on Schedule D. Assuming you are net positive for the year you will save on some taxes. If you were short the stock, it would be more complicated to itemize your margin interest and your paid dividends.

[anxvariety]

Post from yahoo stock message board for LEND.. I thought it was good..

Re: Why would anybody short LEND? (Not rated) 10-Sep-06 10:02 am
Okay, bright person – good question. I have a bunch of reasons. Imho opinion we are about to go into a recession and the weakest sectors/stocks usually get hit the hardest. Also, if you have studied some of the greatest speculators in history ie Jessie Livermore, William Oneil et al., their ideal entry points were to short stocks on the 52 week low and buy on the 52 week high if conditions are right.

Are we headed into a recession? Just like 2000- we have a home index that has been smashed, we have a steep inverted yeild curve short fed funds vs 10 year and we have plunging consumer confidence. Also, a very strange complacency. Yes, there are tons of articles mentioning a doomsday scenario but the market participants are not buying insurance. Near record low VIX: http://online.barrons.com/article_search/SB115715058551 952229.html?mod=search&KEYWORDS=rosen&COLLECTION=barron s/archive

Okay. So why LEND? According to the 10 Q they have 15% exposure in California and 12% in Florida. Even the most adamant RE cheerleaders concede that these two regions are in a bubble that seems to be bursting. True- no big deliquencies yet. But the market, as a discounting mechanism, is beginning to smell LEND’s problems. Even after a giant sell off- it has trouble basing here. Of course, if the bears are right, it wouldn’t take much to wipe out LEND’s book value.

Imho real estate is in a classic asset bubble- global in scope. 200 years of math don’t lie. People do. Those who are planning on interest rate cuts coming to the rescue, I suggest that they study Japan in the 1990’s – when they reduced interest rates to zero. Another example would be Hong Kong in 1997. Rate cuts do not stop the problem once sentiment shifts and the ball is rolling down hill.

Cheers,
RX

[anxvariety]

Another post from yahoo stock message board for LEND…

Why LEND will work it way up to $50
One reason–Its backdoor product–It’s loans are packaged up and sold as ABS bonds. We all knew that ! BUT did you know that once in the bond market investment banks divide up these loans even further by risk. So let’s say you have a low appetite for risk but you like the yield of 10% so you do the math and say I want only the 1st 2 years of those loans —which are the least riskiest and get a very decent yield. Then someone else comes in and says I want the middle years etc… and then the riskiest guys take the last years. Thus the risk is spread out as well as the reward and the buyer who made the correct evaluations wins. THE BIG secret by all these (vulture capitalists) is that the foreclosure rates/bankruptcy rates are in reality VERY VERY low even when houses depreciate. They laugh at “stupid consumers” who thought they could flip their way to riches. These capitalist also buy high risk auto loans, AIRplane loans (ouch), yatch loans—-all seemingly very risky—all are also known as junk bonds —but these loans make them rich and allow the consumer to spend like drunken sailors and keep our economy rolling.

[rseiser]

I am still short a small part of my LEND short (in the interest of full disclosure). What this second guy on the Yahoo board misses is what everyone else in investing misses too, and that is that we are not in an one-dimensional world. Same as in the decline of the Nasdaq, where SEVERAL problems surface at the same time.
For the lenders, for example, they not just have their possible risky loans. If housing prices tank, loan volume might go down dramatically, ARMs especially, and the loan amounts will shrink, too. So revenue will be even lower, cutting into profit margins hard. Next could be competition for selling loans, whatever who can at any price. And even as Rich pointed out, real-estate loans might be seen as riskier and trade unfavorably, even if treasuries’ rates drop. People will have to put up higher down-payments, which leads to lower loan amounts as well. And add to this all the momentum followers, who will get scared to death if the trend is really down. I am sure there are even more reasons that you guys might know about.

[rseiser]

I just re-entered all of my short positions in the home-builders and lenders (whatever I covered before). I think we are at a time in history, where everything comes together, and if one ever wanted to short anything that’s gonna be it. Is tomorrow the proverbial top for many years to come? Maybe I am wrong, and we have another rally between here and year end, and the Dow makes new highs. But after a relentless rally of 10% on the Nasdaq, in the face of worsening news, real-estate roll-over, quarter end mark-ups, start of earnings season, absurd valuations, cracks in hedge-funds and derivatives,… I believe this could be the end of the counter-trend rally.
I don’t want to recommend anything here, but just stating what I do. Should you decide to short any stocks yourself I urge you to read my primer about shorting.

[sdrealtor]

Rightside,
Did you ever buy a house in The Bay Collection. They just dropped the prices by 150 to 200K on the smaller ones in the MLS and are including all upgrades and landscaping. Someone recently closed on a 4,000+ sq ft in the bigger ones(Plan 3 I think with tons of upgrades and landscaping for about $1.05M).

I think SP is in trouble also.

[rocketman]

I checked out your Website and article. I’d like to know what you recommend for short(s) + stops if you don’t mind.

I did a hypothetical watchlist “short” trades with most of the homebuilders plus WAMU and LEND (100 shares each). I am actually in the red about $2,500 since I stared at the beginning of Septemnber. But these trades had no stops and are still going on.

I hope you’re right about this market trend. I missed a good entry point on the way up and I am looking to make it back up on the way down.

Thanks.

[Author]

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