Two weeks ago I decided to sell my shares of E*Trade (ETFC) after concluding it did not fit my investment criteria. It was one of my successful picks for 2010 and I made money having sold puts establishing a base price of $13.50. It closed Friday February 25 at $15.89.

I might not have chosen to post about this except for news that Ken Griffin's hedge fund Citadel Investment Group plans to sell much of its stake in E*Trade Financial. The largest shareholder selling out is news. Citadel will still hold valuable warrants, giving it the option of taking a very large position again, but for now there seems to be a change of heart for them as well.

Shares of E*Trade Financial (NASDAQ: ETFC) caught a boost this morning on reports that Citadel Investment Group LLC, the online broker's largest stock and bond holder, has scrapped its plan to unload 120 million shares over the next three months. The size of the planned sale represented about 10% of the hedge fund's investment in ETFC.

"Citadel believes that the termination of the plan at this time is in the best interests of E*Trade and all of its stakeholders," said the firm in a statement. The massive sale, first announced on Aug. 11, was due to commence today, but Citadel says that no shares have been sold under the plan.

The shares of E*Trade Financial Corp. (NASDAQ: ETFC) took a dive this morning after the online brokerage house announced plans to boost its balance sheet. The company will sell $400 million in common stock, and launch a debt exchange worth more than $1 billion. In a statement, E*Trade said its capital-raising initiatives "will significantly reduce the company's debt service burden."

Back in April, the cash-strapped brokerage was instructed by the Office of Thrift Supervision to quickly raise new capital and reduce its leverage. Today's newly announced share offering and debt swap are expected to bring in at least $1.2 billion, although the transactions are expected to dilute the investments of current ETFC shareholders by about 40%.

The typical structure of a hedge fund can be precarious. For example, there are usually huge amounts of leverage. At the same time, investors can redeem their shares, which often happens in tough times. The upshot: a fund may have to shut down.

Just look at Citadel Investment Group. As of the end of November, the firm's two main funds have lost close to 50%. What's more, investors are requesting redemptions of $1.2 billion, which comes to 12% of overall assets.

What to do? Well, Citadel isn't going to honor the redemptions -- at least for now.

No doubt, this will anger investors. But, hey, in the hedge fund world, the investors are sophisticated, right? Shouldn't they anticipate such things? Besides, other hedge funds have done the same thing (such as Tudor Investment Corp.)

To allay things, Citadel is making a concession. That is, the firm is going to pay its own operating expenses for 2008 (keep in mind that this usually comes out of investor dollars). And this is no small amount, which could be $200 million to $300 million.

The problem is that -- in light of the huge investment losses -- it will be extremely difficult for Citadel to generate incentive fees. So, in light of this, why will top employees stick around? If anything, they may start their own funds.

In other words, Citadel is in a tough spot right now. And, it could easily take many years for the firm to regain its former stature – if it ever happens.

Tom Taulli is the author of various books, including The Complete M&A Handbook and The Streetsmart Guide to Short Selling: Techniques the Pros Use to Profit in Any Market. He is also the founder of BizEquity, a valuation website.

The Dow lost 385 points this week with a 315 point election day rally on Tuesday, two consecutive days which totaled 929 points down, and a Friday rally of 248 points. Did the market rise on hopes of a McCain upset only to fall due to disappointment that Obama won? Did the market rally Friday because the 6.5% unemployment rate was not as bad as expected? It could be, but I doubt it.

More likely, the markets are moving because of the trading behavior of endowments, pension funds, and hedge funds. They make decisions for very different reasons. But some reporting on daily market movements looks like a joke -- nobody knows why the market goes up or down, but commenters use price movements as a daily barometer of the national mood. So how do endowments, pension funds, and hedge funds move the markets? Here's how:

• Endowments. Big university endowments, such as Harvard's, are desperately trying to unload billions of dollars worth of illiquid interests in venture capital and private equity firms. Harvard is reportedly trying to dump $1.5 billion worth of such interests into a market where there is likely to be very little interest. Not only that, these private equity firms are demanding that endowments fork over the money they committed to them so they can make new investments. And with the S&P 500 down 36.6% so far this year, many endowments are selling anything liquid to meet these commitments and to pay shorter-term obligations -- such as paying professors and keeping the lights on.

Microsoft Corp. (NASDAQ: MSFT) -- Bill Gates will give the pre-show keynote address at CES on January 6th in Las Vegas. CES features 2,700 exhibitors spanning 30 product categories. MSFT overall option implied volatility of 29 is above its 26-week average of 24 according to Track Data, suggesting larger risk.

E-Trade (NASDAQ: ETFC) -- ETFC is recently down 65 cents to $4.04. On November 29, ETFC announced a $2.5 billion cash infusion deal from Citadel Investment Group. Bank of America says: "Downgrade to sell (PT goes to $2) as we no longer believe the value of the ETFC's retail brokerage business, a dwindling asset (which has lost 17% of assets already), can offset negative value at the bank." ETFC overall option implied volatility of 111 is above its 26-week average of 72, according to Track Data, suggesting larger price fluctuations.

Daily Options Update is provided by Stock Specialist Paul Foster of theflyonthewall.com

My colleague Peter Cohan covered the Sowood Capital debacle on BloggingStocks a few weeks ago. Interestingly, we're seeing much of the same in a recent hedge fund blow-up, most importantly Citadel's involvement.

Basically, after hedge funds lose investor interest due to poor performance they suffer from redemptions (or withdrawals) of investor capital. When this happens, its a downward spiral because many funds hold positions in rather illiquid securities. As a result, rapidly 'dumping' these positions to the market wouldn't make sense. Therefore, they need a buyer who can come in and purchase these positions at a lesser discount than they would've received if they were forced to quickly liquidate in the open market.

Citadel Investment Group has a growing role in this business. According to a Chicago Tribune piece on the Sentinel sell-out, Citadel bought $500 million in assets for "85 to 90 cents" on the dollar. This means that Citadel paid $425-$450 million for $500 million of 'stuff.' Not so good it may seem. However, I'd bet that Citadel believes many of the positions they acquired are undervalued as other hedge funds sold off the positions on fears that Sentinel would flood the market with supply.

It's becoming painfully clear that hedge fund blow-ups are simply a reality of today's market environment, primarily due to the growing size of hedge funds and their complicated strategies in sometimes-illiquid markets. However, not everyone is suffering. While investors and fund managers at blow-ups are simply 'screwed' by the process, Citadel is able to take advantage of the madness and purchase quality assets at a discount. Although this might seem flawed, Citadel is actually performing a valuable service to both the markets and the blow-up. The markets benefit because they aren't loaded with supply while the blow-up benefits because 85-90 cents on the dollar is likely much better than a figure it would've received in a fire sale.

Hedge fund managers, most notably Steven Cohen (SAC Capital) and Ken Griffin (Citadel Investment Group), have become notorious buyers of expensive and trendy contemporary art. It would make sense, then, that the recent poor performance from many mighty hedge funds would have an effect on art prices because hedge fund managers stand to make less money (or perhaps even, gasp, lose money).

According to a recent Bloomberg article, "the art market will soften...but it may not happen for six months to a year." However, the article also quotes a Moody's analyst who testified that "we've seen record levels of consigning,..and lots of deals are being done." But I tend to agree with the first source -- the art market will inevitably soften as hedge fund managers have less disposable income to invest in their art collections.

This piece, like many others pieces of news, proves the 'domino effect' is unbelievably at-present in the world. News of poor earnings from an American company can effect foreign markets, credit issues in America have created a worldwide sell-off during the last month, increased volatility has hurt many large hedge funds, etc. As I've said before, "gone are the days when simple cause-and-effect can be used to analyze a news event."

Morgan Stanley (NYSE:MS) is playing Pac-Man with hedge funds. According to a Reuters story, the firm has made five investments in hedge funds during the past five months.

The latest deal is a minority position in Abax Global Capital, based in Hong Kong. Yes, the fund will focus on the Asian markets.

True, the markets have been volatile there lately (especially with the big drop in the Chinese equities markets). Then again, hedge funds thrive on volatility. What's more, Asian markets are relatively under-presented in terms of hedge funds.

While Abax is a new fund, its key managers are veteran investors, some coming from Citadel Investment Group.

Why a minority stake? Well, that's probably the only thing offered to Morgan. Also, it is key to provide enough "skin in the game" for hedge fund managers. If they know they can get rich, they will certainly be motivated to get above-market returns. At least that's the theory.

Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements.

Investing seems to be more of an art than science. It's not necessarily about hiring smart people or having super computers. It's usually about one person who has that intangible X-factor.

For example, in 2006, Goldman Sachs' mega hedge fund, Global Alpha Fund, actually sustained a 6% loss. Yet if you look at some of the hedge funds led by legendary investors, things look much better. This is the conclusion of an excellent article in Bloomberg.com.

Take Steven Cohen, who manages SAC Capital Advisors. Last year, his fund returned a whopping 34%. Or look at Ken Griffin's Citadel Investment Group, which also returned more than 30%.

These investors show that success often means going against the conventional wisdom.

In the case of Cohen, he has become more of an activist. One of his plays was to join with Carl Icahn to make a move on Time-Warner. He has also intervened in the $25.5 billion deal between Phelps Dodge and Freeport-McMoRan.

As for Griffin, he made a bold bet buying-up the portfolio of Amaranth Advisors, which was a massive hedge fund blow-up.

Griffin's firm plans to go public soon.

Tom Taulli is the author of various books, including the Complete M&A Handbook and the EDGAR-Online Guide to Decoding Financial Statements.

While reaffirming their focus on keeping inflation in check, the Federal Reserve Board has been passive about interest rate increases lately. The Board has been very clear they will remain inflation hawks and will take action to prevent any significant upward inflationary trend.

In the meantime, Wall Streeters are taking on ever increasing debt with more leveraged buy-outs, issuance of more corporate bonds and preferred stock and the first-ever unsecured bond offering by a hedge fund. According to the December 11, 2006 issue of Barron's, Citadel Investment Group of Chicago sold $500 million of five year notes yielding 6.343%.

It is not just Wall Street, either. In the real estate world the same thing is happening. While mortgage rates have moved up over the last 30 months, they are still historically low. For example, in 1998 we refinanced a property using a conduit loan and were thrilled to lock-in a rate of 6.7% (25 year / due in 10). The best traditional loan at the time was 8.1%. After rates moved down our fantastic loan seems only average but we saved some money and had predictability.

Now we find conduit loans can be had as low as 5.7% and traditional mortgages at 6.2%. These rates are typically offered at a maximum of 75% loan-to-value (LTV), with high occupancy, and credit tenants and may vary during the course of the day, based on many factors. At these rates we are interested in borrowing more money. Our business model is very conservative so we do not pursue maximum leverage. We might only seek up to 65% LTV. However other real estate investors are maxing out their leverage, apparently believing the market rates will move higher in the foreseeable future.

Last week, Citadel Investment Group sold one of the first ever unsecured bond offering issued by a hedge fund, according to Barron's magazine (subscription required). Citadel raised $500 million.

Apparently, Citadel will offer a total of $ 2.0 billion in unsecured bonds. A co-founder of Hennessee Group, a professional hedge-fund cheerleader, called the move "brilliant." The cheerleader further commented that it is cheaper than raising capital from limited partners.

The issue got a triple-B rating from Fitch and the deal was two times oversubscribed.

According to this Fly, this has all the warning signs of a disaster waiting to happen. Does Citadel now take all that leverage and borrow more from its prime broker, borrowing more against its already leveraged balance sheet?

This sounds similar to the mortgage and housing bubble which is currently unwinding. The housing bubble hit peak valuations when lenders were willing to lend at full value or in excess of the full value of the underlying real estate, requiring no equity investment.

In Citadel's case, why raise equity capital from limited partners when you can go out and borrow it? Who needs equity? Good luck bondholders.