Pre-Market Alert: BSC All But Worthless!?

Add DIA Puts Now

PLAY: Buy the DIA April 114 Puts (DIA PJ) within the first 25 minutes of trading.

Dear Bottarelli Research Member,

It was most likely a long, long weekend for Jamie Dimon.

And at the end of it all, the Chief Executive Officer of JPMorgan (JPM – NYSE) may have orchestrated one of the greatest deals of the modern century.

As you already know, shares of Bear Stearns (BSC – NYSE) have been in absolute free-fall — and taking the heat is Bear Stearn’s CEO Alan Schwartz. His clients pulled out $17 billion of funds over the last two days last — putting the fifth-largest securities firm on Wall Street on the verge of bankruptcy.

Poof! After 85 years of independence and prosperity, Bear Stearns has literally been dissolved in less than 48 hours time. Unbelievable.

As of this morning, JPMorgan will give investors 0.05473 shares of JPM common stock for every one share of Bear Stearns stock they own. That comes out to a purchase price of around $270 million, less than one 10th of what BSC traded for last week.

This is quite a remarkable price considering that Bear Stearns’s brokerage unit generated $1.2 billion in revenue last year. Not only that, but just by itself, BSC’s headquarters in midtown Manhattan is valued at $1.2 billion. Nevertheless, BSC decided to sell all of this for the bargain basement price of $270 million. The biggest loser in looks to be Bear Stearns’s second-largest shareholder, Joseph Lewis. He invested more than $1 billion in BSC stock since September, and now it appears like his investment will be close to worthless.

Once again, this is quite an unreal development. In fact, Alan Greenspan wrote in yesterday’s Financial Times that we’re in the worst financial mess since WWII. As of last week, BSC had a book value of $80.00 per share. But today, BSC is only worth $2.00 a share. What does that mean for other financial stocks?

As you can imagine, pre-market futures are dramatically in the red. Therefore, we could have a substantial fear-based selling environment which sends investors running for cover. For example, minutes after the BSC/JPM deal was announced, the Fed cut the rate on direct loans to commercial banks by a quarter percentage point. This emergency move further spooked the markets.

It sure looks and sounds like panic has set in. Now, when all the dust settles, we could have a market that’s close to a bottom. But for now, we’ll respect the downside scenario. After all, the old trading rule is stocks hitting new lows continue to hit new lows. And as I write today, the pre-market futures indicate that the Dow will open at a new 52-week low. Make no mistake, we’re in for a very, very volatile day.

Now, don’t forget similar moves that we’ve witnessed this past January — which saw a dramatic sell-off on the open and a dramatic recovery into the close. Could this happen again? Or will the markets could go into a complete tailspin? It’s anyone’s guess.

In times like this, it’s best to keep our cool and let the volatility shake out. As traders, we will try to make some savvy plays, but at the same time, let’s not try to be heroes. I’ve said it before, but for the near term, reduce your contract sizing and keep your plays tight to the vest. Case in point, as I write you this morning, the only position that we have is FCX April 105 Calls (FCX DA). As of last night, April gold futures hit record high at $1,023.8 an ounce, so despite the massive price swings we’ll inevitably see, I still like this position. Therefore, let’s temporarily eliminate our stop loss and let this position ride. I see no need to get stopped out of an otherwise good trade based solely on excessive volatility. If FCX call prices get beaten down, we may add to this play — along with adding to some other upside call plays I’m monitoring of strong companies trading at or near 52-week highs (like FDG, PAAS, STLD, ASA, X, APA, or JOYG).

But in the meantime, I’d like to follow up on a strategy that I outlined last week that entails getting positioned in DIA protective put hedges. Since this is a pre-market alert, I have no way of telling where the DIA puts will open today’s trading. Nevertheless, I think it’s prudent that we all establish on a small position in the DIA April 114 Puts (DIA PJ). These puts closed Friday trading between $1.92 and $2.19 per contract, and based on this morning’s futures, they’ll most likely open around $2.90. So, at the open of today’s trading, let’s try to grab this position as close to $3.00 as we possibly can. Like I mentioned, I have no idea how they’ll get priced at the open of trading today, but with news like this on BSC, we could be in for a very ugly morning. Let’s buy these puts within the first 25 minutes of trading at market price and try to capture a quick intra-day gain if the markets turn into an all-out bloodbath. Here’s the play:

PLAY: Buy the DIA April 114 Puts (DIA PJ) within the first 25 minutes of trading. Do not place any sniper sell orders, as we’ll re-evaluate this position once we have established our entry price.

We’ll re-evaluate where we stand with this position as the trading day progresses. And as always…

Lock and load!

Sincerely,