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Trading the Insurance Sector

Written By Brian Hicks

Posted March 24, 2009

"Just because you robbed the grave doesn’t mean you killed the guy."

That’s a quote from The Daily Show, drawing attention to the debate over short trading in today’s markets.

We’re big fans of the show. But the truth is, playing the downside of stocks helps keep equities from becoming overvalued.

And while we primarily play options, and not shorts, in the Options Trading Pit, our philosophy remains very simple.

We aim to make our readers money.

Because if they’re not, someone else is.

Now, our style of trading isn’t for everyone. But it’s been working almost flawlessly since the start of the year.

The portfolio tells the tale:




That’s 18 winning trades out of 21 since January 2009.

Part of our success came from plowing through four different sectors, accumulating gains for our readers (many of whom have emailed me to let me know they’d never previously traded options).

Thing is, we’re only getting warmed up.

That’s because we’re honing in on our next profit target:

Insurance Companies: Get a Piece of the Crumbling Rock

We’re convinced the next sector to take a beating will be insurance. That’s right… major names like AFLAC, Hartford, MeLife, and Prudential, to name a few. And one of these very companies could go belly up.

Here’s why.

We see two problems.

1.  Insurance companies are big buyers of corporate debt.

2.  Insurance companies are regulated by states, each of which determines how much capital the insurance companies need to keep on hand based on a "risk based" model provided by the National Association of Insurance Commissioners.

As the corporate debt market falls apart, life insurance companies could fall under capital requirements prescribed per state. If that were to happen, the floor would fall out. . . and just like a bank can experience a bank run, life insurance companies can experience similar runs from those holding policies.

Another problem can come from more dramatic drops in the marketplace. Life insurance companies, for example, often hedge market performance to fulfill contracts.

Heck, no one thought AIG would be under $5, but here we are.

And because of the potential for insurance company failures, we’re looking to short a basket of stocks soon. (We’re still doing our required due diligence… but we’ll have updates coming to you very soon.)

As for the four sectors we’ve played out for major gains, have a look:

The Casino Industry

We knew we had a good bet against Vegas. One company’s earnings were suffering, badly. . . and the same was true of its competitors.

The stock was Wynn Resorts, which we played short on February 3, 2009 with a put option.

Fact was, Wynn was no longer a Vegas crown jewel. It was struggling just like every other Vegas casino. . . smarting from thin crowds and dampened discretionary spending. Its competitor MGM Mirage had its price targets slashed because of it.

And within 10 days, Options Trading Pit members banked gains of 22% and 30%.

Residential Real Estate & Finance

It was February 2007 when my team and I called the top of the housing market, buying puts on the most-exposed companies wrapped up in the lending market. Soon after my readers got on board, signs of credit deterioration began showing up in the results of banks. . . as borrowers began falling behind in payments. (Foreclosures had already jumped 35% in December 2006.)

And for the fifth straight month, more than 100,000 properties entered foreclosure. It wouldn’t be long before mortgage resets and delinquencies piled up, leaving us where we are today.

My readers took home 4,500%-plus gains from housing’s plight, including 44% and 48% gains on Fannie Mae and Freddie Mac, 60% on Masco Corporation, 70% on American Express put options in a day (plus 86% on the same put option in six days), and a whole slew of others.

But we didn’t just play the short side of financial stocks, we played the long side too, for gains of more than 125% on two plays.

In fact, here’s how the trade went down on March 11. . .

Readers were told, "as long as banks are buried under write-downs, they’ll hold on to their cash. And we won’t see any real fix to the financial chaos. That’s why a U.S. House financial services subcommittee is meeting tomorrow to review mark-to-market accounting rules, which make big banks value assets at current market values even if the market is engulfed in madness.

"However, if we get something from tomorrow’s meeting that mark-to-market rules could be changed, the fear holding back financial stocks could begin to disappear. It’s speculation on our part, though. We’re not looking for any permanent changes that’d kill off financial transparency, but we are looking for some kind of relief."

By March 19, 2009, we were out of the positions with gains of 61% and 125% on FAS calls, and 92% and 166% gains on XLF calls…

The U.S. Treasury

Treasuries are today’s biggest bubble. They may not have the characteristics of the Internet, energy, or housing bubbles, but the unbelievable rally in U.S. Treasury bonds is just as doomed as commodities and housing stocks were.

And with that belief, we bought put options on a skyrocketing Treasury trade and call options on a Short Treasury trade.

And we were spot on…

Twenty-one days into the position, we exited half of the call for 34% and half of the put for 38%…

Commercial Real Estate

Mirroring the residential real estate meltdown, the commercial market’s bottom is just now starting to drop out.

Delinquencies are beginning to rise. The meltdowns at some of the biggest commercial REITs could be another blow to a financial system teetering on the brink of disaster.

Trust me, the Fed’s shaking nervously over the prospect of the commercial real estate sector’s deteriorating sharply in the months ahead. That’s because a large number of commercial real estate mortgages will come due at a time when:

  • Banks likely will still be facing balance sheet constraints,

  • The ability to securitize commercial real estate mortgages may remain severely restricted, and

  • Vacancy rates in commercial properties could well be climbing.

Truth is, things are bad. . . and they’ll only get worse before we see sustainable improvement.

The play: We bought put options on a few commercial real estate companies (in falling knife patterns) that were doomed for failure.

And only 6 days into the two positions, we closed 50% positions on each of them for 30% and 38% gains.

As for the insurance trades we spoke of earlier, we’re preparing a full analysis of the companies we’re targeting for maximum gains… which we’ll publish within the next few days. So, we urge you to get in now. Just follow this link.

Good Investing,

Ian L. Cooper
Investment Director, Options Trading Pit