ERICOPOLY

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valuecfa, Given that you are comfortable with the downside of MBI below a given point, I think you could do well writing out-of-the-money MBI puts and using the proceeds to purchase at-the-money index puts. I mention MBI because of your background with the company, as well as it's very high volatility premium relative to what the premium is for the index. Worst case, no gain/no loss. Best case, market drops and you make money. I'm assuming you wouldn't care that much about the risk of getting assigned MBI at $10 or $8. Plus, it seems likely that MBI's premium will continue to decline in this post-uncertainty world for MBI. Right after the pop, I wrote $8 MBI 2014 puts for $1.15. Already they're down to about 70 cents. It should continue to suffer rapid premium decay.

The at-the-money may seem like you are throwing away the premium, but if you are truly hedging and not speculating then you will recover that premium after writing covered at-the-money puts after the market drops. Then the premium on your covered put decays by expiry. Now, if the market rallies once again by expiry you might end up with no profit from the short position. But again, was this for hedging or for speculation? If for hedging, then you should be happy that if the index stays down your profit is intact. And if the index rises, your other positions do too. Volatility rises as the market crashes, so don't worry about being able to recover your premium.

I started to feel better when Mr. Shilling said he expects no US recession, continued 2% growth, stronger US dollar, and that a 27% correction in the stock market would bring stocks back to the appropriate levels. A 27% correction doesn't set some of us back very far (unless of course we do worse than the market) -- about 1,200 on the S&P500 (well above the level that some started hedging). And wow, Roubini sure thinks things are pretty darn good: Regarding the US economy, Roubini was somewhat more optimistic. He feels that the housing recovery is legitimate. He does believe that there will be a manufacturing revival in the US due to lower energy costs and that the shale gas boom will be a massive tailwind for the US for many years to come. All of these together will lead to solid employment growth and should continue to strengthen the US recovery.

I pay less than 1% margin borrowing cost with them, vs 4+% for Fidelity. Using the money saved, I can purchase puts that completely eliminate the "one bad tick" risk. The account is configured for "portfolio margin" (as opposed to "Reg-T Margin"). You see, under the rules of Portfolio Margin, if I buy $5 puts on BAC then my account in effect has $5 of uninvested cash sitting in it (from their point of view). The rules for portfolio margining are simply different -- they look at only your net exposures, and puts effectively free up your invested dollars (below the strike price).

Unless its floating rate debt, I don't get the logic of #1. Why don't you get the logic of #1? Given that defaults are low because of low interest rates, it naturally follows that continued low interest rates lead to continued low defaults. The low rates have been low for years now. The loan portfolio is seasoned such that the remaining credits in the aggregate loan portfolio is either of low rate or they are hardy seasoned credits at higher rates (the weaker credits having already defaulted). I don't understand why there is a correlation between low rates and defaults? Is it because debt service would be low? Weren't rates considered low during 2007? I'm not arguing for low rates as the cause of the low defaults. That was another poster's reply: Defaults are low because interest rates have been low for a prolonged period of time, and corporations, individuals, etc have been able to restructure their debt profile. I'm just aggregating the two replies I got and putting them together. My original remark was whether the economy is really as bad as people say if the rate of defaults is this low. I mean, people argue that if jobs are coming back it's only because they are really shitty jobs, or they argue that young people have no hope, etc... etc... So that all sounds really bad! Except the defaults are really low which indicates a low level of distress out there, not a high level.

WFC has also done two conferences so far this year. BAC is just absent.

Unless its floating rate debt, I don't get the logic of #1. Why don't you get the logic of #1? Given that defaults are low because of low interest rates, it naturally follows that continued low interest rates lead to continued low defaults. The low rates have been low for years now. The loan portfolio is seasoned such that the remaining credits in the aggregate loan portfolio is either of low rate or they are hardy seasoned credits at higher rates (the weaker credits having already defaulted).

A couple of comments based on those replies, and then a question... 1) defaults will remain low because because interest rates will remain low for a long time 2) defaults will remain low because underwriting standards have improved and the weak credits in legacy books have been culled What constitutes a long-time? The earnings yield on S&P500 is 7% annually and the thing that threatens it (higher rates) is a long ways off according to Watsa (and the bond market seems to agree with Watsa, so he's not exactly contrarian in saying this). The trouble I see in using the Schiller P/E over the next few years is that if rates stay this low (as Watsa forecasts) for years and years going forward, then the Schiller P/E10 will begin to look a lot more benign even without a market drop. You will then need a Schiller P/E13, then a P/E 15, etc...

Just a general question... Why are defaults low? People have been saying that the stock market is out of sync with the real economy. However, is it really tough out there in the real economy? Is following default trends on outstanding debt an outmoded means of measuring the real economy? I've heard people say that nothing is really improving out there (except for stock prices and home prices) -- real incomes aren't rising, jobs added are all low quality, etc... etc... Okay, then where are the defaults?

Yes and no. I sold the Jan 14 $100s (premium value rose as they neared strike) and kept the Jan 15 $75 strike. The primary reason is that I've reached an agreement with my landlord for a 3 year purchase option -- so I no longer have any pressing needs for cash. The secondary reason is the desire to lock in the rising premium in the option as it neared the $100 strike. The third reason is tax loss selling -- the tax authorities shared 52% of my losses on this one. I might get around to it today -- I want to grab some SPY puts to replace a portion of it. I can do this without it being a wash sale because it's a different index.

One can also write the BAC call (in addition to the MBI) and therefore the premium from the two of them can easily cover the cost of the BAC $13 strike 2014 put. I think you can get there with the $16 strike BAC call and the $21 strike MBI call. Then you have 2x leverage upside and essentially all of the MBI downside in addition to 35 cents of BAC downside. Both can rise 15% and you have a 30% return. Unfortunately, your max return is capped at 37.5% for MBI and for BAC it's capped at 19.7%. That leaves your maximum return (both of them combined) at 57.2% -- still, it's only until January so if you were hungering for more gains that dry spell won't last forever :)

I like it, but it's too bad the BAC premiums for the out-of-the-money calls aren't higher. I still have a lot of MBI but I've written calls to pay for my BAC puts. For example, the MBI $21 strike call finances the $12 strike BAC put. You could put on 2x leverage this way in your portfolio without any friction from options decay. Worst comes to worst, you've amplified your downside by roughly 10% (the hit you take as BAC goes back to $12) and you've capped your gains on MBI at $21. But this is January 2014 expiry, so if MBI gets near $21 towards the end of the year I'll bet the calls can be bought back very cheap and the 2015s could then be written for additional upside. Remember that story about Rick Guerin and how leverage hurt him? Well.... he didn't structure his leverage such that the maximum hit was 10% from 2x leverage ;D

that makes a lot of sense to me. I'm surprised at how much this cost of leverage value moves for all the various choices (particularly these LEAPs)--I thought it would be a bit more rational/constant on the longer dated ones... The LEAPS have experienced drag too, mostly due to skewness. But you didn't pay for 6 years of leverage, so not as bad! The LEAPS+common approach has added positive leverage since this thread began, vs the warrants that have added negative leverage. The people owning the warrants were effectively owning 6 years of capitalized borrowing costs. 230 basis points of capitalized borrowing costs (multiplied by 6 years!) just got vaporized by Mr. Market. That's a tough hit to absorb (therefore the underperformance vs the common).

So my thinking is that the warrants will continue to experience a painful drag as they go into the money. I'm not sure at what point that effect slows to white noise, but I feel pretty safe in predicting that it's effect will likely be largely played out by the time the stock is at $20.

I'm just a hack. I thought 13% was completely absurd and so I took action. 10.7% still seems steep in this low interest rate environment, but not nearly as bad. I mean, they've already lopped 230 basis points off of the interest rate. I doubt the next 12% appreciation for the common will be this painful for the warrants. I still like the option of adjusting the strike price when rolling, and the warrants don't have that because you are getting married to the strike price for the entire duration. I think that's pretty limiting and if anything it should "warrant" (pun intended) a discount vs the LEAPS, not a premium!

Not sure that first one is smiling. But today the warrants are trading down 1.85% at $5.85. That's only a 4.4% gain since I started the thread. And when I started the thread, that was after I had been selling quite a few of my own -- and I was getting a price around $5.80 when I started (when the stock was $12). The stock is now up nearly 3x the rate of return as the warrants!

So far since this thread began, the common stock has appreciated 12% and the "A" warrants have appreciated around 6.5%. Explanation: The cost of leverage in the warrants has dropped to 10.7% annualized from 13%. The computation: You have $13.44 to buy 1 share of stock at today's close. You spend $5.96 for 1 warrant at today's close. You have $7.48 left in cash ($13.44 - $5.96 = $7.48) $7.48 grows to $13.30 (the strike) in 5.67 years at 10.7% annualized rate (the cost of leverage)

I think Sears is an awful retailer that will never get turned around, and thus we may finally be getting somewhere with the stock after Eddie finally gives up on Sears the retailer and gets some other tenant into that real estate. Sort of strange that my logic revolves around how terrible the Sears retail stores are. I guess I am not that confident with only 4% invested but usually I find it easier to add than to make the initial outlay. Why do you figure that they will all be in trouble? I don't personally value the real estate. I have this loosely coupled team of free analysts that have done that and I don't think I'll be any better than them so I saved myself the effort.

Here are some lyrics that speak to the siren song of the markets: Dear Prudence, won't you come out to play Dear Prudence, greet the brand new day The sun is up, the sky is blue It's beautiful and so are you Dear Prudence won't you come out to play Dear Prudence open up your eyes Dear Prudence see the sunny skies The wind is low the birds will sing That you are part of everything Dear Prudence won't you open up your eyes? Look around round round Look around round round Oh look around Dear Prudence let me see you smile Dear Prudence like a little child The clouds will be a daisy chain So let me see you smile again Dear Prudence won't you let me see you smile? Dear Prudence, won't you come out to play Dear Prudence, greet the brand new day The sun is up, the sky is blue It's beautiful and so are you Dear Prudence won't you come out to play

I think Sears is an awful retailer that will never get turned around, and thus we may finally be getting somewhere with the stock after Eddie finally gives up on Sears the retailer and gets some other tenant into that real estate. Sort of strange that my logic revolves around how terrible the Sears retail stores are. I guess I am not that confident with only 4% invested but usually I find it easier to add than to make the initial outlay.

I got sucked in today for 4% position. There ought to be an "ask txlaw" thread as I think he is pretty much always right.

Has anyone else noticed that we get less info from BAC these days? JPM had an investor day. BAC did not. JPM posted UBS Global Financial Services Conference webcast on May 14th. BAC did not. JPM posted Citi 2013 US Financial Services Conference webcast on Mar 5th. BAC did not. BAC has not been busy lately on this front. BAC has only posted annual and quarterly earnings presentations thus far this year, and beyond that they seem to have no further comment. I admit I'm kind of used to the relatively frequent stream of information coming out of these conferences, and this is boring.

I am disappointed that the stock is at $13.35 with all this talk of a mega-bubble building in the markets over on the other thread. It's going a lot higher in order to catch the market if stocks are that overvalued. 10x forward earnings isn't bubble territory. EDIT: Especially when the 10x is only 10% ROTE.

Yahoo Finance reports the forward P/E at 10.43. That's what the casual observer sees (in addition to the trailing P/E that you mention).