2 Short and 3 Long Short-Term Plays

07/19/2011 12:30 pm EST


Michael Shulman

Editor, Short-Side Trader

Europe’s debt crisis and the US combat over the debt ceiling has created an environment rife with opportunities on both the long and short side, writes Michael Shulman of Short-Side Trader.

The short-term view of the market depends on technicals, earnings, and Greek bailout talks. It depends on the current run on Italian bonds; it depends on how badly Majority Leader Eric Cantor wants Speaker of the House John Boehner’s job; and it depends on how the ratings agencies will really react in the lead up to the Aug. 2 debt-ceiling deadline.

You get my point.

The bottom line is that we will be in a trading range for at least another month, with earnings- and Fed-driven liquidity fighting the bearishness of the Greek and US debt debacles. That range is a pretty big 1,250 to 1,350 on the S&P 500, and the bias is shifting to the downside.

The European debt crisis and the US debt-ceiling debate are picking up steam, and—while you may forgo some profit from the long side of your portfolio by being conservative—some lost profits are infinitely better than hits to your capital.

The issue is no longer whether Greece will default, but what form the default will take, and whether it will spread similar contagion around the continent. The difference in interest rates required by investors for Spanish and Italian bonds, compared to German bonds (what the TV gurus call the spreads), is the largest since the formation of the Eurozone.

Further, these spreads are widening every day. Fear is now so palpable that traders are pushing up the yen and buying Treasuries, despite a dead Japanese economy and a brain-dead political situation in Washington.

This is a slow-motion crisis that’s steadily picking up steam—with European equities and dodgier bonds from Greece, Ireland, Portugal, Spain, and now Italy losing value every day.

I sense a short-term lull in the headline-driven bearishness, but stay tuned because more quick-hit profits are on the way when the market situation is a bit more favorable.

In the US, things are truly getting worse in Washington, DC, as a power play inside the Republican Party has derailed the debt-ceiling talks. The man supposedly in charge of his own caucus and party, John Boehner, has been undermined by his No. 2, Majority Leader Eric Cantor, who is insisting no new revenue can be brought in as part of a debt-ceiling compromise.

This is going to push the negotiations past the legislative deadline of July 22—the theoretical date to have an agreement. That in turn will prompt pressure from the bond-ratings agencies and create more urgency.

The bottom line is, we probably go to the brink, and all the while Wall Street is yawning over the whole thing, as The Street still cannot believe the politicians would blow up the world financial system.

I think that Wall Street will take a lot more notice of the debt-ceiling situation, and I also think that in the coming days we’ll begin to see newspaper columns by legal scholars knowledgeable about the debt limit issue that state the President does not require the approval of Congress to raise the debt ceiling.

There are more "fun" and profitable trades to come!

NEXT: Short Side:


Short Side:

Apollo (APOL) August $35 Puts (APOL 110820P00035000)
This online educator (operating as the University of Phoenix) is worth $20 a share, tops, once federal regulators catch up with its abysmal graduation and loan-repayment rates. I thought that would have been clear by now, but even if it is, ferocious lobbying has prompted some congressmen to get in the way of the Department of Education’s crackdown on online universities.

Barring a market crash, or major negative headlines, we won’t get to the $35 strike price. This position is a "Hold" for now.

Bank of America (BAC) August $11 Puts (BAC 110820P00011000)
The stock is fading fast. It’s just punishment for the company that bought Countrywide and Merrill Lynch—and in the process inherited all their problems. This morning’s edition of The Wall Street Journal had a piece about the deterioration of the company’s core capital due to increased loan loss reserves and a settlement(s) of mortgage issues.

Long Side:

Corning Inc. (GLW) August $22 Calls (GLW 110820C00022000)
GLW is a pure play on the iPad and the tablet market. I believe the sell-off in the stock has been the result of profit taking—the same is true for the stalling and sell-off in Apple (AAPL) shares.

If debt-crisis bearishness can combine with a great Apple earnings report—and it will be great—GLW has a chance to pop. [Apple reports in a few hours…better get cracking—Editor.]

Will it get to the $22 strike price? Odds are against that happening, but the calls could rise quite a bit. These calls are at two pennies, and they’re the ultimate long shot.

Lowes (LOW) October $25 Calls (LOW 111022C00025000)
This is a longer-term position that I believe will pan out. When people can’t or won’t sell their homes, they maintain them—from paint to carpet. The stock took a hit with general concerns about the economy and spending, but I believe Lowe’s earnings will surprise traders.

Peabody Coal (BTU) January 2012 $75 Calls (BTU 120121C00075000)
Why this company sold off so far and so fast is still a mystery to me. World coal consumption continues to rise, and several major users of nuclear power are rolling back their use or walking away from nuclear energy as an option for generating electricity.

We are a long way away from the strike price, but I’m keeping it open for now. The stock is oversold and in the coming months should rise, pulling our calls up.

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