Regarding short-squeezes: the way to avoid getting squeezed out is to not have on outright short positions (or excessively large option premium exposure) once market sentiment reaches panic levels. Even if the stock is ultimately going to zero, if you get a 100% rally then your short sucked and was wrong. So, any time the VIX gets high enough you need to cover outright shorts and shift to short-dated puts. Same if your favourite short has a blizzard of bad news and is down 50% intraday or some such. Either it gets wiped out in a week or two or it doubles/triples in the same period. A good example was FNM/FRE in July, I had been short as a core position but shifted over to the puts and placed stops on my outrights once they had got down into single digits. As a result I took some losses once the bottom was in, but it was far less painful than if I had stayed outright short. And my long-dated puts (which I held) have now recovered all their losses and are above where they were a month ago. If you are ultimately right then the Jan 09/10 puts are the way to go - they give ultimate staying power. Book some put profits into panics, cover your outrights (or at least bring stops up), and only keep on short-dated puts once panic is in the air. I had the same issue with stocks like CFC and MBI in 07 and early 08. It takes a while to get the hang of it and I'm not fully there, but shifting from long-dated puts to outright shorts to short-dated puts as the fear and thus the bounce/squeeze risk gets higher seems to me the best way to play it. I did a pretty extensive post-mortem after that July rally, here are my main conclusions: 1) With a short, it is not enough to think the stock is going down massively over the long-term. You must also have a high conviction that the stock is not likely to rally 75-100% or more in the meantime. If you think the stock could realistically double, then use puts not outrights. 2) When panic selling and huge price declines occur, especially if on some kind of negative news announcement, or if the VIX approaches panic levels (30+), then you should always book some profits, and minimise your exposure to a short squeeze. My preferred way is to cover outrights and/or use close stops, take profits on most of your long-dated puts, and shift the remaining exposure you want to short-dated puts (real or synthetic by buying calls). 3) If you are still convinced of the long-term case, then once the rally gets going, wait for sentiment to become complacent and the stock overextended, then start averaging into long-term puts, buying a few more each week for the next month or two until you get up to full exposure. This worked well in Feb, April/May, and looks to be working well again now. Because they are puts, you don't risk getting slaughtered by averaging.
I agree with getting out once the market has reached panic extremes. I learned this lesson painfuly on the SocGen/MLK low. Was long SKF and saw part of my profit vanish as quickly as it came, fortunally I held most of it and when the vix reached 29 and the fed announced primary dealer tools on the week before the BSC low, I got out. End up missing the BSC crash but I had little choice since financials went up about 3% on the primary dealer facilities day. On the FNMFRE/SECShorts low I was covering the 2 and 1 week before but decided to hold the FNM WB shorts because I felt whatever rally came would be temporary and I could miss a crash. One thing I will add is that a vix 30+ is not necessary for a big short squeeze and sudden shifts in sentiment. I'm saying this based on a statistical research I read going back many years. the simple fact that the market went down a lot usually leads to rebounds even without high VIX. the author said a high vix is a 'nice to have' but not a necessary setup
I'm not short WB(indirectly tho through SKF) but I expect much more carnage there thanks to Golden West acquisition in 05 and being idiotic enough to still be doing pay option loans until a few months ago.
FNM and FRE continue to plunge. My decision of not adding during this decline might seen a bad one now in retrospect but I'm not so sure it is. Its easy to get bearish and call for a $0 when the stock is plunging and its interesting how the 'fre fnm' thread didnt got much agreement when they were soaring and shortsqueezing me all the way to $18 on fnm. When they nosedived everybody is calling for zero. it certainly possible they will continue to fall and be worthless in a few days but I dont thats likely You see, in capitalism the system in inherently biased towards survival and turnarounds, way more often than not you see things happen that will lead towards companies surviving, this is a big lesson I learned on MBI, private equity firms, analysts they all jumped in saying they were a good deal. In this case I dont expect survival but what the market does is what matters, the constant optimism of fund managers and investors might be a side effect of the trend in capitalism of towards survival and wealth creation(BSC etc are the rare statistical anomalies) Plus the short side of this stocks is massively crowded right now so any kind of 'positive' news will lead to surge. So unless you can handicap the odds of nationalization in a few days its hard to make a big bet here That said I plan to add small sums to the short positions, if I'm wrong and they are nationalized this weekend then I will just make less profit, hardly terrible news. I also doubled my WB yesterday on the 3.5%+ rally, I want to get ahead of the move here, I expect the market to get really worried about pay option arms in the coming months
The market merely going down is, in my experience, not enough to generate a lasting low - at least not in a bear market. For a bull market where you are near recent all-time or multi-year highs, things are different I agree. In a bear you also need sentiment to reach at least fearful levels. Many extended declines were met with complacency and thus went much further than the norm. Only once people stop bottom fishing and start selling in fear, without much regard to price or value, do serious bottoms get made IMO. The big selloffs in 2000-2002 were classic examples. May to July this year was another good example - it was eerily reminiscent of the 2000 selloff in that people *kept* trying to bottom fish every few days. Only the "FNM/FRE will fail" meme finally killed bottom-fishing attempts en masse and brought out the panic. As for getting squeezed, I've found that sometimes I get squeezed out of outrights (e.g. FNM/FRE last month I covered poorly - didn't cover enough at the panic lows, and ended up covering after they had almost doubled from the bottom), usually at a bad time; whereas I never get squeezed out of long-dated puts. Maybe I should keep 100 shares outright short, and then whenever I get squeezed out of the short due to a huge rally, use it as a contrary signal and double up on my put position! Regarding forum "noise" about FRE/FNM etc - that's the way sentiment works. When we have just had a big loser we don't want to talk about it because you'll just get people taking shots - "How could you hold that during a 75% rally, noob!". Even if you are short from $50, if you sat through a $5 to $15 rally then you just wanna forget about it. Once the stock turns back to new lows and you feel vindicated, you feel ok talking about it again. It's a good contrary signal, definitely. That's what's so great about those LEAP puts, you literally CAN "forget" about them. I have on some CORS puts I first bought in 2007, the stock has had many big rallies but ultimately keeps going lower. I would have made a bit more by being outright short, due to saving on time decay, but I almost certainly would have been squeezed out. I can't hold a 5% short position with a maximum upside of 5% in the best case, and watch it double or triple in my face for a 5-10% loss. I can hold a 2-3% LEAP put position and watch it go up 3, 5, 10 fold in a year. I also held off adding recently on these declines. There are 4 scenarios: i) the stocks are oversold and pretty soon some news comes out, or they just bounce based on a broad-market rally. 50-100% rally in a week or two, then they turn back down and ultimately go much lower. ii) the stocks keep going all the way to $0 in the next few weeks. 100% fall. iii) the stocks ultimately survive and go way higher. 100%+ rally over the next 6-12 months. iv) the stocks keep going lower, and have a large short-squeeze later (e.g. in 2-3 weeks time). Large dip followed by large squeeze bringing us back to today's prices in about 3-4 weeks. Only in scenario ii) does it make a lot of $$$ to add into a big decline like this one. Option iv) is a missed opportunity but you get a second chance to reload. So IMO, it's best to add to shorts on major rallies of 50%+ in these situations, not into 50%+ declines. If you were good/lucky enough to load up on the short side in the previous 3 weeks or so, then if anything you'd want to be booking some profits and only leave your core short position on. Short into rallies and complacency - cover (partially) into sharp declines and fear.
Scenario v) FRE and FNM continue to plunge, and they bottom at about $1 per share. There is a "large" short squeeze that sees the stocks double to $2, and they continue to trade in a range between $1 and $2, and then in September they are nationalised, with the stocks becoming worthless.
http://www.minyanville.com/articles/index.php?a=18620 Beyond Fannie, Freddie: Three More Problem Children? Good article about RF, WM and LEH m22au's list of financials to short: FRE and FNM WM LEH, MER, WB, RF AIG (GM and F excluded from this list because they are primarily carmakers)
Can this trading game be sick sometimes, I found more pleasant to see MBI go down three days in a row than the entire GSE move. That stock really taught me a lot even though it cost me money, in terms of trading but also accounting and running business, at this point if I figure its worth it even if it turns out they find a way to survive. I want ride them all the way to a bankruptcy filling, even if on a reduced position. Ironically had MLK day not been a holiday I would have made a killing, insert your favorite racist joke here The WSJ reports freddie is trying to sell shares, hopefully this will start a short squeeze allowing us to short some more. If there is a big rally I plan to be aggressive and take a big short as a percentage of my net worth. if they dont move much then I will just wait, I promised myself I wouldn't fall to chasing shorts out of greed. its a hard thing to do but I think for every fnm fre that I miss I will see a bunch of abk,mbi,jpm,wfc,leh short squeezes that I will be tempted to cover on
Excellent article by Mish today about 11 financial entities on the brink: http://globaleconomicanalysis.blogspot.com/2008/08/ten-financial-entities-on-brink.html The list: LEH WM FRE, FNM CORS, BKUNA, DSL WB RF MBI, ABK He also mentions that GM and F are disasters.
XLF went up almost 4% on friday and year WB and WM went DOWN, usually on buy financials day's these stocks soared 5-10%, the market seem to be waking to the payoption arm I'm sort of throwing the towel here on a big rebound of fnm and fre. The market seem uncertain about the value of their shares, that uncertain wont go away untill the Treasury says something, the treasury cant give a positive note because now a private offering is almost impossible(and paulson worked in the underwriting business so he ought to know) so the shares will stay depressed. back when fnm and fre did their massive surge the market didnt know what would happen so they let their bias lead them to buy first and ask later, plus you had all the shorts trying to get out. I think we will get a few intraday rallies(maybe as high as 30%) there but I dont see a 100% move anytime soon, my adds now are on FNM because I believe its more overvalued(now when the perma rebounder throws the towel like that you know its the bottom). I've added about bit on friday, I'm still avoiding taking a big position because of the uncertainty