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Where Financial Crisis Meets Opportunity

Written By Brian Hicks

Posted October 11, 2008

Volatility is worse now than it was following September 11, 2001.

At last count, the ultimate market fear gauge – the VIX Indicator – sits atop 72. 

To put things in perspective…

Following 9-11, the VIX spiked to a high of 40. 

Yet, since the Dow started its death drop from its record high of 14,000 a year ago, the VIX hadn’t budged above 35… not even with the popping of the housing bubble, the Bear Stearns collapse, multiple bank failures, tightening credit, and pitiful consumer and housing data.

That is, until September 26 – the day Congress failed to pass the bailout bill, which sent the VIX to 46.  But even now, days after the $700 billion bill passed Congress, the VIX is hitting new highs of 70, as global recession fears and nervous investors pull out of the market… reflecting unprecedented levels of anxiety.  

VIX chart

And there are no firm analyses that we can apply to suggest or even guess at where the VIX may top out.  Despite how high the VIX currently is, market extremes have yet to weaken.  Nor does it mean that underlying fears have been eased.

We simply have to wait out the "massacre" that could reveal Dow 7,000 before all is said and done.

Even Jim Cramer is scared. In case you missed it, here’s what he had to say earlier…

"Whatever money you may need for the next five years, please take it out of the stock market right now, this week. I do not believe that you should risk those assets in the stock market right now."

And even as Cramer described the $700 billion bailout plan, which includes raising the insured rate on bank deposits from $100,000 to $250,000, as a "good one," he duly warned that the same may not be true for stock market investors.

"I’m worried about unemployment. I’m worried about purchases that you may need. I can’t have you at risk in the stock market," said Cramer.

No surprises here for us. Tell us something we don’t know, Jim…

The mess we’re now forced to endure is a result of subprime spillover, ignored or just plain missed by Ben Bernanke and Hank Paulson… since early 2007.

You may recall Bernanke’s infamous statement:

"We have spent a bit of time evaluating the financial implications of the subprime issues, tried to assess the magnitude of losses, and tried to determine how concentrated they are," Mr. Bernanke said.  "There is a sense that, although there is always a possibility for some kind of disruption … the financial system will absorb the losses from the subprime mortgage problems without serious problems."

He also said he didn’t expect the subprime problems to have significant spillover to the rest of the economy… not to mention Hank Paulson’s over-used "at or near bottom" theory.

But we knew they were wrong. In fact, my team and I have been preparing for this meltdown since February 2007. 

At the time, we had this to report in a Wealth Daily editorial:

Truth be told, when it comes to an "improving" housing market, do yourself a big favor. Ignore the mainstream press, and Wall Street hot shots that would have you believing in a housing bottom, or the illusion of priced in lending weakness.

We’re still not nearing a housing bottom, or an improving lending market.

Just ask companies like Lennar, KB Home, and DR Horton, who still don’t see this mythical housing bottom. Or, just ask Mortgage Lenders Network USA, which just filed for Chapter 11 protection, becoming yet another casualty of the lending market in a slowing housing market.

As for the lending market, we were so bearish on the sector that we recommended that readers load up on New Century Financial (NEW) put options two days before the stock fell $14+. While readers already cashed out with 89% gains on the first half of the position, they’re still holding the second half, watching as the stock craters even more.

Truth… Sub-Prime is Doomed…

Among the worst hit lenders are the sub prime lenders, or those companies that make loans to borrowers with less than perfect or poor credit histories. While sub-prime lenders charged higher interest (two or three points higher than prime lenders) as insurance for the higher risk the borrower represented, rising foreclosures have left the sub-prime industry facing substantial fallout risks.

Sub-prime lenders could offer adjustable or teaser rates to those with bad credit. Loans like this made up 23% of the U.S. mortgage market in 2006 as compared to the 8% in 2001, according to Yahoo News. And it’s now a big problem, as one in five sub-prime mortgages are now ending in foreclosure, according to the Center for Responsible Lending as mentioned by Yahoo News.

The Lending Market has not bottomed… nor has it priced in all negativity.

I’d love to sit here and jump on the bullish housing bandwagon that dominates Wall Street. Really, I would. But I’m not a fan of flushing my money down the toilet.

In reality, the housing market has not bottomed. Sub-prime lenders are doomed. You can continue to listen to the delusional madness pouring from the mouths of Street analysts, and the mainstream press, or you can listen to the homebuilder CEOs and the sub-prime lenders that have gone belly up because of a weak housing market.

It’s your choice. But I’d go with the latter, though.

Even JP Morgan’s CEO, James Dimon, is bearish on the sector, saying, "’Mortgages are the one area of sub-prime lending where ‘we really see something taking place that looks like a recession….’"

That’s just an inkling of the tumultuous future for sub-prime lending.

Just calling it like we see it…  identifying the trends… ahead of the curve.

Look, you didn’t have to be a Harvard economist to see where we were headed.

But it did force us to prepare…

…Not just to protect our portfolios and nest eggs from today’s savage market downturn, but actually profit from the spiral.

And that same preparedness and vision have secured our Options Trading Pit readers gains like:

Fremont General September 2007 12.50 puts – 291% in 16 days
Lennar January 2008 25 puts – 279% in 40 days
Pulte January 2008 15 puts – 224% in 40 days
New Century January 2008 25 puts – 214% in 16 days
Centex January 2008 25 puts – 207% in 40 days
Countrywide January 2008 27.50 puts – 203% in 69 days
Thornburg October 20 2007 puts – 188% in 6 days

…Along with these successful profit plays…

MGIC Investments December 35 puts – 175% in 80 days
Capital One January 2008 65 puts – 160% in 59 days
Accredited Home September 2007 7.50 puts – 141% in 4 days
Hovnanian November 2007 17.50 puts – 136% in 13 days
Radian Group August 2007 60 puts – 122% in 19 days
Standard Pacific September 2007 15 puts – 111% in 2 days
Autonation January 2008 20 puts – 105% in 49 days
New Century January 2008 25 puts – 89% in 1 day

And the gains will keep rolling in, because we’re calling for it to get worse…

You see, while the National Association for Business Economics expects a solid recovery by mid-2009, with GDP approaching 3% by close of 2009, we think they couldn’t be more wrong.

For starters, they aren’t accounting for Option ARM resets, which will turn out worse than subprime. 

Secondly, the markets have come to the sobering realization that:

  • The $700 billion rescue won’t work quickly enough to unfreeze credit markets, and
  • Banks are still having a tough time accessing cash.

Fact is, it’ll take a long time for bank hesitancy to lend to one another, to businesses, and individuals to clear up and convince the markets that they’re healthy again.  There is some hope, however, that the Fed, coupled with other banks, could cut rates again to prop up the economy… but even that’s not a given.

Good thing there’s still a way to profit…

In fact, we just closed out two more huge winners in the Options Trading Pit. We closed our AIG calls for 125% and 100% gains, and half of our iShares Emerging Markets Index December 2008 32 put for 68% gains. 

And that’s on top of these profit-taking options plays:

  • Lehman Bros. January 2009 10 put: gains of 208% and 135%
  • Morgan Stanley January 2009 15 put: 71% gain in less than a day… on half the position
  • 62% gains on Murphy Oil put options…
  • 26% gains on Currency Shares British Pound Sterling December 2008 put options, and…
  • 208%, 133%, 95% and 49% lightning-fast gains on Lehman Bros. in an average of two days.
  • 133% and 100% gains on AIG call option in days.

Please understand… we’re not out to revel in our victories, especially while most investors suffer mounting losses. But you should know that profits can be made in any market… even in this horrific bear market. 

And you only have to look as far as the Options Trading Pit track record to see where the money’s being made.

I’m talking about fast-moving options plays that can double your money in a week, or a few days… sometimes even after just a few hours. 

And if you’re concerned over risk, consider this…

My team and I are on a tear… having executed 20 winning options trades out of 23, earning readers an average gain of 85% since May 2008. 

We do it by pinpointing the companies on the cusp of massive share price moves, and exploiting them for huge gains. 

The second we identify our next winning options play, we issue an email alert… recommending either a put (an option that’s profitable when the stock price falls) or a call (an option that makes money when the stock price increases).

We make it as easy as possible.

And the Options Trading Pit service comes at a fraction of the cost you’d expect from most options services. In fact, you could easily make back the cost of our research many times over… in just a couple of weeks. 

So if you’re ready to start enjoying the kinds of profits that OTP readers have come to expect from my team and me, I urge you to take a trial of our service here

Good Investing,

Ian L. Cooper
Investment Director and Managing Editor,
Options Trading Pit

P.S. We’ll be issuing our next trade soon, so don’t hesitate to become an Options Trading Pit member right now