Merrill Lynch & Co., Inc. (NYSE: MER) stock is falling after the company announced that it will cease subprime mortgage operations through its First Franklin Financial unit. MER expects to incur $60 million of charges related to the move. The troubled financial stock plans to cut 650 jobs and will try to sell Home Loan Services, a unit of First Franklin that handles billing and collections. If you think this stock won't be rising too far in the coming months, then it could be a good time to look at a bearish hedged play on MER.After hitting a one-year high of $95.00 in May, the stock has hit a new one-year low today. This morning, MER opened at $47.30. So far today the stock has hit a low of $46.01 and a high of $47.40. As of 12:10, MER is trading at $46.40, down $2.92 (-5.9%). The chart for MER looks neutral and deteriorating, while S&P gives the stock a negative 2 STARS (out of 5) sell rating.
For a bearish hedged play on this stock, I would consider an April bear-call credit spread above the $60 range. A bear-call credit spread is an options position that combines the purchase and sale of call options to hedge risk in case the stock doesn't do what you think but still leverage nice returns. This particular trade will make a 4.2% return in one and a half months as long as MER is below $60 at April expiration. Merrill Lynch would have to rise by more than 29% before we would start to lose money.
MER hasn't been above $60 since December and has shown resistance around $54 recently. This trade could be risky if the financial sector gains its footing soon, but even if that happens, this position could be protected by resistance MER might find around $58, where it topped out in January.
Brent Archer is an options analyst and writer at Investors Observer. At publication time, Brent neither owns nor controls positions in MER.
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Reader Comments (Page 1 of 1)
3-06-2008 @ 8:12PM
Americas Watchdog said...
Hi Brent;
Interesting blog. We have the National Mortgage Complaint Center & Merrill cannot close its sub prime doors...............they stepped in it big time, and it will take more than new shoes to correct the problem. While they can sell First Franklin, only a fool would purchase the buy back provisions. So we think they are stuck for the long haul. They and other brokers/investment bankers also have to talk to the pension funds about buying back the garbage mortgage portfolios they sold them.............thats another bunch of big checks. Merrills problems cannnot be cured unless it invloves devine intervention.
As far as financials getting a "footing". Sorry. They lost their legs in a land mine accident that they planted & then stepped on. No...financials will not get well for a long time and many will not survive.
& then there is Uncle Ben and the Fed doing a bang up job at getting us to $5.00 per gallon for regular for gas by July. This will also be very good for economic growth. Ben's efforts by the way have had zero impact on mortgage rates. There is just too much risk right now. Why finance a $200,000 mortgage today that will be worth $180,000 in December?
We were thrilled Walmart did good today. The only problem; the closest one is a long way away for most Americans. And its hard to ride your bike to get there. Driving there will be too expensive.
With all of this going on........where is the SEC & Justice with indictments?
On the topic of the SEC, any thought of doing a blog about "auction rate preferred shares (ARPS). This is another $300 billion dollar problem. If anyone has one & wants to get the low down give us a call.
And it was just when you thought Wall Street could not get any more stupid or greedy. They did, and now its time to pay the bar tab.
We'd recommend Gold or Silver and finding a good place in your back yard to bury it.