Ares Trading

Amid the current Bernanke-Paulson hearings regarding the federal $700 Billion bail out plan, Ares Trading has shifted its positions.  After this mornings announcement of Buffett’s $5 Billion stake in Goldman Sachs, Ares Trading expected financials to see some upside.  The broad market started off with steam but moved sideways through most of the day, following the Q-n-A with Bernanke and Paulson.

The XLF position was stop-lossed at 50% loss and closed out. Although the strategy to exploit the wide swings in XLF caused by new developing news events was decent, the execution was poor.  The calls were purchased too early and should have been purchased at lower premiums.  As the VIX spikes above 40 once again, there are tell-tale signs that XLF and the market will have a short term rebound.  Yet, for Ares Trading, the risk exposure to the XLF calls were too much at this time.

The AAPL calls are regaining their value slowly as AAPL stages a rally today.  Although this article is clearly biased, Ares Trading likes the points made by the author supporting AAPL.  As previously stated, Ares Trading expects AAPL to crush their earnings estimates come September 30th, and trade the October calls for a profit as soon as possible.

As a hedge against general market downturn, Ares Trading has established a considerable position long Gold.  Using the GLD ETF, Ares Trading has purchased 2x November 08 Call 95 contracts today at 3.00 a piece.  If the bail out plan finally goes through, the value of the dollar will face a sharp decrease, conversely moeny will be invested in gold, raising the price.  If there is no bailout, the markets will drop further, and panicked money managers will invest in Gold, causing an price rally.  In addition to these fundamental factors, Ares Trading has discovered various technical indicators which hint at a upcoming rally.

Here is the current state of the positions at a a 20% loss:

XLE opened today up around 7%.  The October 71 Calls were sold at $3.65, originally bought for $1.26, returning 190% in 1 day.  Ares Trading has decided to take profits off the table in the current volatile market.  Ares Trading is now formulating its next trading opportunity.

The ECB, Japan, and US have pumped billions into money markets to stave off liquidity concerns.  The US has announced overnight a systemic resolution to the current credit crisis.  This resolution is rumored to have the following components:

1.  Creation of a government entity similar to Resolution Trust Corporation during the savings and loan crisis which will buy bad debt and hold it for a period of time. This will allow banks and other financial institutions to take these toxic securities out of their balance sheet.

2.  Ban on short sales of various financial companies at least until the end of the year.  This has already been enacted in Europe.

3.  Create some type of federal insurance plan protecting those invested in American money-market funds.

These rumors have lead to massive gains in the equity futures market.  Globally, Asia and Europe markets responded very well to the news, both markets moving up aggressively.

The panic and fear of liquidity concerns which caused Gold to go up 15% in a few days is now disappearing.  Gold (GLD) will definitely face a trend reversal today but it is too flaky to bet on.  Especially with no official congressional resolution passed, there is no certainty in Gold’s direction over the next few weeks.

The proposed ban on short selling will help lift the financials (XLF) out of their oversold territory.  This is a trading strategy Ares Trading is considering.  In addition, Kraft Foods (KFT) has replaced AIG on the Dow Index.  The stock price has actually rallied the last month and has room to go further.  Ares Trading is long on KFT.

Whole Foods (WFMI) has experienced a huge resurgence in its price.  Ares Trading had attempted to trade October puts on WFMI but was stopped out of the position the next day at a 20% loss.  Whole Foods is owned 95% by institutions and is currently in the accumulation phase by these companies.  Thus, Ares Trading cannot go short against the current momentum, but is still short WFMI medium-long term due to fundamental factors.

The energy index ETF (XLE) is poised to rebound after the recent news of government aid.  The energy market has been highly oversold during the recent sell-off.  Ares Trading has initiated October Calls and will hold them until the end of September, depending on XLF’s movement, to maximize gain.

Chesapeake Energy (CHK) had onced reached a peak of $70/share in July and has seen massive insider buying by its CEO.  Currently trading at $38 and change, $4 above its 52-week low; Ares Trading is long CHK.

The VIX (Fear Index) fell below 35 to 33 at the end of trading Thursday, September 18th.  This could be a sign that the market has bottomed out, or it could signal an upcoming false rally.  Ares Trading views the current market poised to go up in the short term.  However, Ares Trading does see risk of another short term sell-off based on new news and information dealing with financial mergers.

Ares Trading is back from a brief hiatus with new trading ideas.  The current positions page has been updated with the new trades for September.  There are a few changes at Ares Trading.  The principal being traded has been increased to $3,000.  Thus, larger positions and longer expiration contracts can be traded.  In order to minimize risk/return ratio Ares Trading will now be focusing on trading index options.  Nasdaq (QQQQ), Dow Jones (DIA), S&P (SPY), and Russell (IWM), will be heavily traded.  Also, sector ETFs such as XLF (Financial Sector), XLE (Energy Sector), and DBC (Comodity Sector) will be researched and traded extensively.

Aside from the sector plays there are a few new individual company ideas.  There is a classic acquisition arbritrage opportunity with International Rectifier (IRF) and Vishay Interntechnology (VSH).  This article in IT world discusses the takeover bid by VSH for IRF.

“Chip maker Vishay Intertechnology Inc. said Wednesday it has raised an all-cash bid to buy to buy power management chip maker International Rectifier Corp. and will take the $1.7 billion offer directly to shareholders.”

VSH doesn’t want IRF, it needs IRF in order to remain competitive in the semiconductor industry.  Thus, it is raising their bid and going hostile in order to takeover IRF.  This presents the classic opportunity to short the company that is buying (VSH, since their cash levels will drop and they will face integration costs with the new company), and long the company being bought (IRF, since they will be bought at a premium).  Obviously, this strategy doesn’t always work but in this scenario Ares Trading believes the play will be profitable.  (As of 9/12/2008, 10:45AM, IRF is up ~2%, and VSH is down 5%)

Another position has been initiated in Whole Foods (WFMI).  Ares Trading believes Whole Foods will decline due to lowered consumer discretionary income.  In addition WFMI has fallen ~30% for the last 3 months.  The in-the-money put contracts were purchased when WFMI was up 1.5% for October expiration.

Here are the positions for September.  Profits have already been taken from trading the IWM (Russell Index).

Unfortunately, the DBC Commodity has tanked and the calls have lost nearly all their value.  This has been caused by the dropping oil and natural gas prices, who knew a correction was due?  Actually, Ares Trading had heard some speculation of a commodities correction but didn’t consider it valid.  The good news is the overall monthly positions are close to even at -0.23%.  There is about a week and a half on the DBC calls, hopefully they will regain some of their value.  This wouldn’t be too surprising especially with Russia’s assault against Georgia, which will cause oil supply issues due to pipeline problems.

New positions will be initiated after expiration Friday on August 22nd.

The following positions were closed and will be discussed in order: DIA, F, QQQQ, XLF

DIA: The Dow Jones Industrial Average dropped on Monday, creating 50% profit for the put position.  However, the order wasn’t made before the close of the market.  On Tuesday morning the contract was sold for 46% profit before the rally started.  This was an example of great timing.

F: Monday’s drop in the Dow Jones Average affected Ford’s shares as well.  These put contracts were trading at around 40% premium, however the order did not make it before the close of the Monday market session.  Similar to the DIA position, these contracts were sold for 32% profit Tuesday morning, before the rally.  Another example of great timing.

QQQQ: The Nasdaq index rallied on Tuesday as well, ending up 2.45%.  This position was opened at a time when these call contracts were overpriced due to volatility.  Thus, even with a dramatic increase in price the contracts only sold for 9% profit.

XLF: This position was sold at the wrong time, an example of BAD timing.  The call contracts were down around 40% the day before.  Ares Trading played conservatively and cut losses short at 17%  in the morning, as XLF began its rally.  Ares Trading did not have faith in the upward momentum.  As the financial sector rallied with the overall market, the contract increased in value.  If these contracts were sold at the end of Tuesday instead of the beginning, they would have sold for $1.86, resulting in 5% profit.

There is an inverse correlation between the Dow Jones Industrial Average (measured by the DIA Diamonds ETF) and the DBC (Commodities Tracker ETF). This is a logical relationship since when oil costs are high, the market, in particular, industrials do poor. Thus, when oil prices rise, gold, and other commodities will rise, all part of the DBC ETF. In response to higher oil and commodity prices, the Dow Jones index will suffer, as the market will turn bearish on stocks.

Ares Trading believes the recent upswing in the Dow Jones average will be corrected as oil returns to above $135 a barrel. Consequently, Ares Trading has bought naked calls on the DBC Commodity Index ETF and naked puts on the Dow Jones Industrial Average (DIA ETF).

Ford Motor is having a tough year. Rising fuel costs have ended the “Big-Vehicle Era”, and Ford is having a hard time adjusting. Ares Trading believes the recent rally is a perfect opportunity to be bearish on Ford. Thus, naked put contracts, at $5 strike, have been purchased for August expiration. Ares Trading believes Ford will retest $4.5 lows set early in July.

Technology is a safe bet right now. In the recent rally, Financials have been the only sector to experience a large upswing. However, during the sell-off all sectors were hit very hard, especially technology. This has created unusual valuations for many strong technical companies, many of them being underbought. Ares Trading believe there is strong upside risk for Tech, and thus bought naked calls on QQQQ (Nasdaq Index ETF).

The final position Ares Trading initiated today was in XLF. This is a contrarian position and is being used as a hedge against the QQQQ and DBC position. Ares Trading believes that if Financials are to perform well, then Commodities (DBC) and Technology (QQQQ) will suffer. Why? This is because any positive news will provide enough for a large upside swing for Financials. This will cause market makers to sell off Commodities and Tech, in order to switch assets into Financials. In addition, Ares Trading believes that Financials have been highly oversold. Although fundamentals problems exist, they will continue to exist until 2010, and there is no way to predict a bottom for Financials.

If there is any movement in Financials, it will be dramatic and thus Ares Trading believes the upside risk outweighs the downside risk. Using naked calls on XLF (Financial Sector ETF), Ares Trading is betting on a dramatic momentum shift before the third week of August, similar to the recent market rally.

Markets continued to sink lower in Friday’s trading session. The US Consumer Confidence data for June came in below expectations at 56.4 (56.5 expected). This shows a drop in Consumer Confidence from May, when the data was at 59.8.

CCRT was down 7% at one point, which is when the put positions were in the green. They have been sold for negligible profit. Ares Trading was able to avoid the 75% loss the position had incurred two weeks earlier, before the FDIC announced its plans to penalize CCRT for “deceptive marketing practices”. PRGS, ZMH, and SSL will all be closed out in the next 2 weeks.

Current Position Performance:

Current Position Performance:

The Dow dropped ~360 points and the S&P has retreated below 1300. Oil Futures spiked above $140 a barrel. Is the current oil spike caused by a fundamental supply/demand issue or is it being affected by speculators? The Fed didn’t change the Interest rate, which means that it will be at 2% through Q3.

Current positions:

All the open positions, except for CCRT, are currently calls (ZMH, PRGS, SSL), thus being effected very negatively today. CCRT continues to go down and the position should be closed with profit by the end of the first week of July. ZMH, PRGS, and SSL calls will need to be sold by the first week of July as well, because they are uncovered and are way too volatile in this market.

Progress Software (PRGS) actually beat their earnings but they lowered their guidance, which in turn lowered their multiple.  The call positions have lost practically all their value.  This was a speculative play based off PRGS beating their earnings.

Ares Trading believes it would be prudent to write off these positions, with loss, and start fresh with hedged positions better acclimated to the current market environment. The positions are currently around 3 weeks from expiration.