Shorting HBS, the Bigger they Are
Short recommendation by Daniel Jones, of OptionsNotions
Short Recommendation: June 2008 $75 strike price puts on HSBC Holdings (NYSE symbol: HBC)
Current Price: $78.55
Note to investors: The last time we visited this stock on October 27th, 2007, the stock was nearly $96 and we recommended January 2008 $95 strike price puts for $4.00. We realized profits on those puts at over $15 in the money. We see a similar potential here for the next few months.
As before, we believe the bigger they are, sometimes the harder they fall. HBC took the lead in moving their exposure to Structured Investment Vehicles, or “SIV’s” that was off the balance sheet fully on to their balance sheet back in January of ‘08. It was a bold move. Unfortunately, we think that move will impact the bottom line - negatively - with a dollar number that could measure in the billions. There is massive consumer debt exposure here that could also impact the shares negatively.
HSBC Holdings: The Bigger They Are, the Harder They Fall
(posted at Seeking Alpha)
HSBC Holdings (HBC) is a United Kingdom-based banking and financial services organization. Its international network comprises over 10,000 branches in 82 countries and territories with headquarters in London. HSBC provides a full range of financial services to more than 125 million customers. HSBC has recently been on a buying spree, acquiring banks in South Africa, Argentina, and Australia. In 2003, HSBC also bought Household Finance, which was a market leader in credit card and home equity loans in the U.S. Subsequent to that acquisition, HSBC has had to close the mortgage origination division of Household, and take several multi-billion dollar charges against earnings for the losses stemming from that acquisition.
As we have all been reading, foreclosures and delinquencies have surged in recent months, particularly among homeowners who took out high-risk mortgages. The distress has forced several mortgage lenders into bankruptcy and stoked anxiety that the problems are now spilling over into the broader economy. As these impairments to value continue, banks are taking multi-billion dollar charges for their mortgage backed bonds, SIVs and consumer (credit card related) debts. We see the potential for a significant negative impact to HBC’s earnings and / or equity value here from exactly those vehicles.
HBC is heavily exposed to credit card assets. In that light it is similar to Capital One (COF), which recently slashed its earnings estimates by over 20% due to higher default rates and building losses. We see potential for a negative impact to earnings from this exposure as well. In this situation and in this credit climate, the risks are not necessarily outweighing the rewards. We still feel a short position presents a compelling opportunity.
Chart Discussion
HBC’s current chart shows a meaningful rise in the stock price in the September – October 2007 timeframe, which was concurrent with the Chinese market’s latest run, and the Fed’s interest rate cuts.
Since then, the stock has been hacked pretty severely – by over 20% - and the moving average indicators and relative strength lines are also struggling to turn positive. With daily moves of several dollars appearing in recent months, there are numerous gaps in the chart.
We think the high for the shares was back at the $98/$99 range 6 months ago, and the risk / reward for a short position is still quite favorable.
We believe the likely top in this stock for the next few months or so was in November 2007. We also believe shares could trade down another 15% to 20% or so, to a level below the $66 - $65 price point within the next three months as continued fallout from the credit market (the SIV’s, subprime mortgages and credit card defaults) impacts the industry, and HBC specifically.
Recommendation
We would recommend investors consider buying the HBC June 2008 $75 strike price puts, which are currently at $4.50 bid / $4.70 ask. We would seek to exit those puts when the stock reaches a price point of $65 or lower, or when the puts are trading at $10 apiece or more.
Put spread buyers may want to buy the aforementioned June 2008 $75 puts, and sell the June 2008 $65 strike price puts for $1.45 (current bid). This would limit the risk an option spread buyer would have to approximately $3.25 ($4.70 for the long June $75 option, less the $1.45 for the short June $65 option), and also limit the potential upside to a maximum profit of $6.75 ($10.00 spread differential, less net cost of the spread).
Disclosure: Analyst has no HBC positions.
ilene9