Distressed Volatility

I'm looking at Chesapeake Energy again for a quick trade to the $50 area. From their website, they are the 3rd largest producer of natural gas in the US, and 2nd among independents. They own interests in approximately 39,000 producing natural gas and oil wells and are producing 2.3 billion cubic feet equivalent per day and 92% is natty gas.

Charts From Bigcharts.com





It looks like CHK was in the low $40s earlier this month, lows not seen since February of this year. It rallied all the way to $75 in July and closed at $48 today. It touched $50 a few days ago and could pierce through that important resistance level if a positive catalyst presents itself. It looks like it has corrected along with price of oil and natural gas. The second chart above shows the comparison between CHK and the Natural Gas ETF (UNG). The Natural Gas ETF is currently at the December 2007 support levels. It appears there could be a near term technical reversal, the sell off in energy is looking tired at the moment..

Looking directly at CHK's call volume compared to puts, it appears that there was massive call buying today at the out of the money SEP 50, and 52.50 strikes.. October didn't see much interest so this looks like near term bullish sentiment. This could be related to the tropical depression forming in the Carribean as well as the Russia/Georgia war or flat out energy price reversal.

Tropical Storm Gustav Forms in Caribbean Near Haiti (Bloomberg)

Gustav, packing winds of about 60 miles (96 kilometers) per hour, was about 165 miles south-southeast of Port-au-Prince, Haiti, and was moving northwest at about 12 miles per hour, according to a National Hurricane Center advisory issued just before 8 p.m. New York time.

Gustav's center may be over Haiti tomorrow and may develop into a hurricane before making landfall, the advisory said.

``We could see a major hurricane by the later part of the week,'' said Jim Rouiller, a senior energy meteorologist with Planalytics Inc., a forecaster based in Wayne, Pennsylvania, whose clients include energy companies. ``Right now, it looks like we have a very dangerous hurricane taking shape over the central parts of the Caribbean.''

Option Data From Yahoo Finance




We'll see what happens with this.

Lehman is seeing some strength and interesting options activity after last week when the South Korean Development Bank said buying Lehman was a possibility but the price offered was too high. This is after Dick Bove upgraded Lehman Brothers to Buy, saying Neuberger Berman could go for $7-$10 Billion in capital which would price Lehman at nothing on the market, most likely due to the valuation of mortgage debt on their books.. He thinks it could be ripe for a hostile takeover, and had a $20 take out price. Bove also thinks Lehman is trying to get a 20% premium to book value or a price in the $40s, which he feels "doesn't have a prayer" (Bloomberg video). He says Lehman does not want to sell at these distressed levels. Also noted, Citigroup analyst reduced his price target from $50 to $35 due to his estimate of a $2.9 Billion asset related write down in the 3rd quarter.

Lehman Volatility & Put/Call Volume Charts
Sourced From Schaeffersresearch.com
LEH Put/Call Volume vs. Price
Schaeffers Volatility Index (8/22)
It looks like volatility is moving higher, along with lows in the put/call volume chart not seen since October, 2007. The put/call volume ratio is sitting at about 1.20, and it looks like it was at parity a couple days ago. There seems to be a tug of war in sentiment and the rope doesn't seem to be moving in either direction. One side will give when the news cataylst comes out of either a buy out, sale of assets or none of the above. From a brief look at the call/put open interest chart on schaeffersresearch.com, it appears that there is a large amount of Put open interest at the SEP $5, $10, and $13 strike, with about 32,000 puts open at the $10 strike far outpacing the number of calls. However the OCT $30 call contract has the most open interest with over 24,000 contracts.

Now about the short interest, as of 8/1 about 82 million shares are reported short, and from the look of the chart it's at all time highs, so either we're in for a huge move to the downside or a massive rally is about to occur if the shorts get squeezed...

Technical Chart Analysis (chart at top of page): It looks like LEH has been gathering some strength from the RSI, also volume has increased to the 100 Million share level. It broke a key $15 level, however it closed on strong volume ending at $14.41. If we do see a positive catalyst and it breaks above the $15 mark again, we could see $17.50, or $20.00 where the top of downward trend channel exists along with the 50 day moving average, if $15 fails, down we go.

I'm looking at Yahoo again, it popped higher along with the overall market on Friday. Here's a look at the chart on Tuesday's set up and Friday's chart.

Tuesday (8/19/08)
Friday (8/22/08)
We're finally starting to hear news about Internet/TV convergence, with news from Intel and Yahoo this week (Intel and Yahoo! to Bring the Internet to Television). It's about time, I think it's a huge opportunity for Yahoo given it's huge internet property base and programming/branding opportunities. With the ability to use a set top box or direct TV integration to converge the two mediums, it will be a milestone when people catch on.

With so much video content on the internet, it was inevitable that this would occur. I think internet programming will slowly take over the advertising base of regular television network programs. Yahoo needs to lever its audience base, programming abilities, and cash to consolidate this industry. As you can see there is a huge fragemented market and I see it with financial internet sites, and with other genres, and I believe they are competing directly with CNBC, Fox News, and Bloomberg for advertising revenue even though they have their own internet sites. You can see internet networks and television networks overlapping as well, partnering up, but with internet available on HDTV now it could sever the friendship. With so many different internet programs, and with speeds allowing for video streaming and HDTV integration, the big network owners (Disney, News Corp, GE, Time Warner, Viacom) definatley could use an internet platform like Yahoo to converge their programming outlets and advertising base. There's also a war in search going on right now and Google is dominating the space. In July, according to Comscore, Google's search market share registered 61.9% of all hits, while Yahoo had 20.5%, and Microsoft 8.9%. In order to compete with Google in search, a Microsoft buy out of Yahoo seems right. Yahoo is also leveraging it's services to get into the mobile space (Yahoo OneSearch finds a home on your Nokia, Yahoo! launches mobile voice search in RP) which is also a big market to tap. It's also interesting that more and more network content is able to be streamed on the internet, for example fancast.com lets you watch full episodes of current and old television programs from Doogie Howser MD to the Colbert Report. Also movies via netflix.com are also able to be seen on your HDTV with an enabled device. Convergence is here!

Volatility and Put/Call Ratio Analysis Snapshot Charts from Schaeffersresearch.com

Schaeffers Implied Volatility Index (8/22/08)

YHOO Put vs. Call Open Interest Spread

YHOO Put/Call Volume

Looking at overall sentiment, it looks like the Put/Call Volume chart has been trending down since March right after the buy out offer from Microsoft. There could be a pop in this stock before put activity starts to shine. Also the Schaeffers Volatility Index is at lows not seen since June, and could break down further if there is no catalyst. The next burst of volatility could be forming a bullish case for the stock however it all depends on timing, as no buyout offer or a quarter with lower growth would bring in more bearish sentiment and push the stock down even further. I believe that a potential buy out is bringing in most of the call open interest.

GM 1 Year Chart (BigCharts.com)

I saw a lot of bullish call buying in the GM options On Monday morning (8/11/08, with oil hitting fresh new lows and right before Rick Wagoner, chairman and CEO came out and said "the worst may be over for the beleaguered carmaker, in terms of US job cuts, retiree healthcare costs and pension problems", the August $10.00 calls were seeing thousands of contracts being bid up, and eventually volume picked up in the $11.00 strike in the thousands. The stock was at $10.20 when this was going on and it hit a high of $11.75 today before pulling back.

The chart looks very interesting. It seems that a double bottom COULD be forming, with the increasing relative strength index knocking up against 50 along with a MACD right along the 0 line (which could break out confirming an uptrend). GM is also in a long term downward trend and could knock up against it's upper channel and the 50 day moving average (12.29). This week option sentiment activity moved directly with oil fluctuations and GM announcements, which were mainly bullish this week, and the 30 Day Volatility Index (chart below, courtesy of ise.com) hit a previous mid July low of 89 as of today's close. GM hit a week high of $11.88 today before pulling back to a $11.18 close. News about a potential asset sale are also in play and could be a potential trading opportunity. Also, oil's direction is key to the movement of GM. It could break out to the upside from here which would bring in massive bearish sentiment to GM and the autos, or oil could resume it's downtrend and GM implied volatility could break down further as investors stay content with the long GM trade. We shall see what happens.


GM Volatilities (ise.com)

USO (Oil ETF) Chart (BigCharts.com)

WCI Communities, the award winning builder of retirement and golf communities consisting of homes and condos in high rise towers mainly in Florida and the North East, wasn't really relaxing in the sun during the past year and a half. Finally though WCI is resting in peace, after repeated actions of trying to restructure its 4% convertible senior subordinated notes due 2023 that had a $125 million put date on August 4, 2008, which investors decided to redeem in full for cash. WCI did not have the liquidity available to pay off the notes, and if they did, it would have violated existing debt covenants using cash on hand to pay off those notes, so they tried to refinance them with secured notes paying 17.5%, giving it more security as well as shortening the expiration to 2012. They also sweetened the deal by providing a warrant to purchase 33 shares for each 1,000 principal amount. This transaction required that 95% of the 125 million be swapped. It's interesting that the convertible debt was being bid up about a month before the put date, they were pretty big sizes and could've been used to block the transaction or try to utilize the put at par realizing a nice cash profit. Bond activity information used from Finra.org.



And the funniest part of the story is there was a fake fax message sent to all of the media outlets in Florida that WCI received a $5.25/share bid to buy the company!

"WCI Communities said it was victimized by a phony press release Saturday that said the financially strapped luxury developer had received a buyout bid of $5.25 per share. As the buyout rumor circulated Monday morning, the company's stock shot up 37 cents per share, or 27 percent. WCI rushed out a press release denying the "false media reports," and the stock dropped back to its starting price of $1.37 per share. It closed at $1.39. WCI is best known in the Tampa Bay area for developing Sun City Center and the Westshore Yacht Club. As of late Monday, the company hadn't discovered the source of the fake news report, but suggested the U.S. Securities & Exchange Commission would look into whether someone was trying to pump up the stock to dump shares at a profit." Link

This all happening while S.A.C Capital is unloading millions of shares before the Aug 4Th put date, thousands of put contracts were bought sporadically during July at the lowest (2.50, 5.00) strikes, and 15 million shares were short. It's a conspiracy! Someone long needed some liquidity fast to get out, and the shorts were getting ready for the big BK!

The swap transaction ultimately failed and WCI filed for Chapter 11 bankruptcy. Here are quotes from the Chairman Carl Icahn, owner of 15% of the company..

“The company, with all diligence, has attempted to avoid a bankruptcy filing. However, the filing became necessary because of the recent failed effort to obtain financing and the recognition that the company’s entire $1.8 billion of debt may soon be in default. This was confirmed when certain holders of the company’s $125 million convertible notes informed the company that they rejected its exchange offer and instead insisted on being paid in cash in full on August 5, 2008.”

WCI went into bankruptcy cash flow positive with a $5.64 book value (Assets $2.13 Billion - 1.94 Liabilities), however banks were appraising the secured assets and some came in less than book value. From the 2Q press release:

"These lower than expected appraisal values could potentially trigger a mandatory repayment obligation in future periods. Thus far, we have received appraisals on assets totaling approximately $700 million of which aggregate appraisal values exceed 95% of book value, however, the ratio of appraised value to book value received to date may or may not represent the ratio of appraised value of remaining inventory." There was also commentary in the Naples News

2007: Icahn Vs. WCI
It should be known that in 2007 WCI's previous board of directors turned down a $22 tender offer by Carl Icahn thinking they could get a better deal. This was a horrible idea because the housing industry was crumbling, especially in Florida, and now a year later the company is in Chapter 11 bankruptcy trading at .30 on the pink sheets.

In late 2006 and the beginning of 2007, Carl Icahn accumulated about 15% of the company and S.A.C Capital, High Bridge and Sandell Asset Management had just under 10% of the company trying to capitalize on a sale of the company. Carl Icahn and his affiliated companies then made a tender offer for WCI at $22/share on 3/23/07 if certain conditions were met (poison pill and Delaware law condition). Icahn's tender offer expired 2 months later because the company declined and did not agree with the conditions. In July WCI still couldn't come up with buyers for the company, and it was trading around $10/share and during this time I remember thousands of puts were traded at the 10.00 and 7.50 strike. It eventually hit $5 in the beginning of August.

Icahn was able to get the chairman role and get his nominees on the new board (including SAC and Sandell) at the August 30, 2007 meeting. Also at the beginning of September, 2007 WCI terminated the sales process because it received NO buy out offers. The previous board, headed by Don Ackerman, really screwed over shareholders who wanted out at the best price possible.

Carl Icahn's words from the SEC filing on 3/13/07.

"Carl Icahn concluded that "this tender offer will be in the best interests of all shareholders in that it would provide immediate liquidity at a premium for those shareholders who are concerned with the current housing industry downturn while also providing the opportunity for those shareholders who, like us, believe in the long-term prospects of the company to realize any potential upside."

WCI's reply's to Carl Icahn's offer from "WCI Rebuffs Icahn Buyout Bid" (TheStreet.com).

WCI said late Thursday that the $22-a-share offer is "highly conditional, opportunistic and inadequate from a financial point of view." The board instead plans to seek a sale on its own, and hired Goldman Sachs to help in the effort.

``WCI's Board of Directors believes that the Icahn tender offer is not in the best interests of all stockholders,'' said Chairman Don Ackerman. ``We reached this conclusion after carefully considering the tender offer price and terms, as well as the advice of our financial and legal advisors."

Carl Icahn's words from the SEC filing on 5/21/07

"Carl Icahn announced today that the any and all cash tender offer at $22.00 per share for shares of WCI Communities, Inc. expired at midnight, Friday, May 18, 2007, with none of the approximately 10.8 million shares tendered being purchased by his affiliates. This resulted from the failure by WCI to redeem the poison pill and meet the condition regarding Section 203 of the Delaware General Corporation Law. Mr. Icahn stated that he will have much more to say about this subject, but it is sufficient to point out that WCI prevented its stockholders who were desirous of achieving liquidity at a substantial premium from doing so. Mr. Icahn further stated, "I hope for the stockholders' sake that WCI has a bid for the Company better than $22.00 per share or else it was reprehensible to take away this opportunity from them. Should WCI fail to achieve such a sale price, we hope that stockholders will support our proxy fight to unseat the current Board of Directors."

In Conclusion:

Due to the beginning of the credit crisis and the distressed housing situation moving into the end of 2007 and 2008, WCI was able to stay alive for 9 months by amending important bank covenants, including the Debt/Tangible Net Worth ratio and EBITDA/Fixed Charges limit. WCI was lowering prices as much as 40% to unload as much inventory as they could to raise cash. Using the cash they could receive from their contract receivables, they were able to pay down 350 million of long term debt during the first 6 months of 2008 (1.92 to 1.58), however the net effect of the asset write downs didn't help out the NAV. They were also able to sell the Tuscany Reserve property for $65 million, however they realized a huge loss. Unfortunately for WCI it was horrible timing for asset sales to reduce debt obligations because land values were selling for distressed prices, and the high cancellation rates, lawsuits and daily operation expenses weren't helping the cash flow situation. The only thing that could've saved this company was a cash injection from Icahn, an overseas buyer utilizing the cheap dollar, or a private equity firm with a long term investment horizon. I don't think it was viable for Carl Icahn to inject 100s of millions of dollars, over his $120 million initial investment, to refinance the convertible debt as well as the other debt coming due. It's too bad because housing should be bottoming in 2009, and housing equities would reflect that before it actually occurs. With not enough cash coming in and cheap land appraisals, WCI had to reorganize to deal with their massive interest payment obligations.