A *short* case study - WAMU (symbol: WM - NYSE)

I thought I'd take 15 minutes on this beautiful Sunday to share some thoughts on one of the potential shorts for this fall - Washington Mutual we'll look at the technical damage first which I consider first followed by some interesting fundamental analysis and statistics from the 10-Q and 10-K.

Technical:

First we want to examine the potential execution zone for the trade - that is where would we want to initiate the PUTS positions. I think the convergence area of the 50 day and 200 day moving averages is a highly probable rally point where the stock could bounce down off of a more clearly defined resistance area in the $44 area.

Our next question is what the potential settling prices for this stock would be out 4-5 months. I am looking for retracements in the 20%, 35%, and 45% areas. The potential leverage of this position could exceed as much as 70 times the equity so you can anticipate that the risk reward is high - probably in the area of 1 to 70 if the correct cost basis is attained. What does this imply? These options are being priced based on the past 6 years historical volatility levels and not on the foundation of a probable market downturn in the 20-30% range over the coming 4-5 months as I expect. I also expect the forthcoming developments to shake our finance based economy to its very core.

I expect major home lenders such as Washington Mutual (probably the biggest lender in America) - and at a minimum the largest residential portfolio lender to rediscover both default and credit risk in loans that it considered highly credit worthy based on traditional metrics such as FICO scores.




Now let's anaylze the profit potential of these various plays trading the January 2007 $40 PUT options. I am looking for entry cost around $0.50 a contract which I don't believe will be obtainable until the stock retests the resistance level at the moving averages convergence area around $44.

The following would be the profit potentials at each zone based on current options pricing ($1.35) as well as the desired execution zone of $0.50.

$36 target area:
Current pricing profit potential - $4-$1.35= $2.65 profit / $1.35 cost= 96 % profit potential Execution zone pricing profit potential - $4-$0.50 = $3.50 profit / $0.50 cost = 600% potential profit

$30 target area:
Current pricing profit potential - $10-$1.35= $8.65 profit / $1.35 cost = 540% profit potential Execution zone pricing profit potential - $10-$0.50 = $9.50 profit / $0.50 cost = 1800% potential profit

$24 target area:

Current pricing profit potential - $16-$1.35= $14.65 profit / $1.35 cost = 985 % profit potential Execution zone pricing profit potential - $16-$0.50 = $15.50 profit / $0.50 cost = 3000% potential profit

As noted above there are some great potential trades here and their potential will depend heavily on the entry costs. In fact - before reviewing the actual nuts and bolts of the potential profits I was unaware of the high risk/reward of these setups.

Fundamental:

I am a little tired after all of that and need a nap. :0) - I will shoot for the fundamental analysis later this evening or this week.

Best regards,

BG