Goldman Sachs Bets Against Risky Financials (WM, MER, LEH, WB, NCC, FRE, FNM)

This morning we have another negative note out of Goldman Sachs calling for investors to be long volatility in financial stocks where the options prices are reasonable in companies that have exposure to troublesome assets like subprime CDO’s, subprime RMBS, exotic mortgages, commercial real estate loans, Alt-A, and leveraged loans.

Some of the stocks noted were as follows:

• Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE);
• Washington Mutual (NYSE: WM), National City (NYSE: NCC), and Wachovia (NYSE: WB);
• Merrill Lynch (NYSE: MER) and Lehman (NYSE: LEH).

Goldman Sachs expects these names with more exposure to be volatile as future write-downs should correlate with total exposure.  The firm recommends buying put options and "put spreads" to position yourself for downside in the sector and these specific names.  The firm is expecting more negative news in the coming months.

If you want a brief description of a put spread, we put in a link here from Investopedia.

We would note that we also expect more negative headlines for the sector as yet another wave of troubles is coming via resets and defaults in Option-ARM loans.  But we’d also like to note that the worst has already been seen in "some" of the stocks.  There will likely be some more failures that go into bank failures rather than mere mortgage lender failures.

Jon C. Ogg
February 29, 2008