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The CDO Slide
Author: Ravi Prakash (info)
Website: http://www.optionstradinglessons.com/
Posted: November 12th, 2007 at 9:50 am EST
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There are opportunities every single day on Wall Street to make money trading stocks and options. The trick is knowing what to trade and timing. Timing is crucial, I can be right about the general trend but if I am wrong on the timing then it translates to losses - at least on paper. I read the VIX chart incorrectly on 10/21. Since then the Market has taken a caning that it has not seen for a long time (reminds me of my Catholic boarding school). What I do not understand is why public firms that have absolutely nothing to do with the sub-prime CDO market are being sold. Some have fallen more than 20% recently, while the fundamentals of their business remain sound. I am talking about the non-financial sectors.
It seems like there is no end to the losses financial institutions keep announcing every other day. The problem is that in spite of the Feds pumping money into the credit market, it still remains illiquid and pricing of CDO securities remain a mystery. If banks and hedge funds cannot fix a price on their CDO holdings they do not know what they are worth and thus cannot accurately tell how much they are losing. This creates uncertainty and the Stock Market is reflecting its feelings towards this uncertainty. The one thing it really hates.
There have got to be others who like me wish that Mr. Bernanke would just be honest with Congress and the public regarding the extent of the problem and what he intends to do to fix it, regardless of how the Stock Market reacts. He seems to be juggling between inflation, the real estate market, the tight credit markets, sky rocketing oil prices and the falling US Dollar. Surely he realizes that he cannot make people on Wall Street (his buddies???) and politicians in Washington DC happy simultaneously. Pick one Uncle Ben and go with it.
Oil hit $98 during the week. This has got to be putting pressure on inflation. Something has to give in the end. It seems to me like the Feds are afraid of some big financial firm or big mortgage firm going under. Why? Dropping interest rates and pumping money may only delay the inevitable collapse of some big firm. Nobody likes pain I guess.
There is most definitely an element of panic on the Street right now. At times like this the best thing to do is just hold on and do not join the selling only to take a big loss. I would also like to point out the importance of picking the right option series to trade. More specifically the expiration one chooses. There are no guarantees of profit when trading options, but you increase the odds in your favor by giving yourself 4, 5 or 6 months before expiration. You might have noticed all my trades for the past month have been for April 2008 expiration. It gives me the luxury to wait out the current mess and sleep well at night. Panic trading nearly always ends in losses. Since 1987, I have been through many such situations. If you are worried, the best thing you can do right now is nothing. Take a break and stop watching the Market ticker every second.
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