My analysis on MER(12.43 +0.87 +7.53%, ) was spot on, but I lost money on the play.

As I wrote here a while ago, I bought Sep 08 $22.50 put options for  MER because I knew that the fundamental of this company is so messed up.

I saw the value of those contracts deteriorating as the financial sector bounced up during the FRE(0.82 +0.05 +6.49%, ) and FNM(0.84 +0.02 +2.44%, ) drama.

The government involvement worried me, so I decided to sold those contracts at a significant loss (over 40%).

Looking back, I think it was a good decision because the play was very speculative.

Here’s why. I knew that the business was so dying so I knew that sooner or later, the price would go down. The problem is I didn’t know whether it’d be sooner or later.

I knew what would happen, but I didn’t know when it would happen. That made this options play speculative and that’s why I lost money.

What does the recent MER(12.43 +0.87 +7.53%, ) deal with Lone Star mean? Marek Fuchs from The Street explains it in plain english. Here’s the take away:

These securities, after all, were valued at $11.1 billion a few weeks ago when Merrill reported its quarter results and are now being sold for $6.7 billion — but that’s not even the troubling part. See, the buyer would take the bucket of slop only if Merrill financed most of it. The company did — 75% worth — with debt whose only collateral are the assets that Merrill is selling. What does this mean in plain English?

Merrill is still open to tons of risk.

The company really only took out 25% of $6.7 billion, or $1.675 billion of risk, off the balance sheet.

Last week, after watching interview with Nouriel Roubini at Tech Ticker, I was convinced that the big brokers are doomed.

Since I was out of my MER(12.43 +0.87 +7.53%, ) short, because I foolishly entered a stop order in panic when the big rally happened last week, I tried to enter the short position again. I wasn’t able to do that because there was no share available to borrow from my broker.

I suspect that it was so due to the short restriction that the SEC applied to protect 19 major financial institutions including MER.

That protection creates an artificial supporting force that caused a big rally in the financial sector. Once the protection is gone, the stocks will drop like a brick.

2 alternative actions that I could take in place of doing a short:

1. Buying the ultrashort financials SKF(135.00 -15.35 -10.21%, )
2. Buying the put for MER

I decided to go with option no 2. I bought the MER Sep 08  $22.50 put at $2.47/contract

In order to do that I had to cover both my MAR and UPS short positions. Then I also bought the UPS Jan 09 $55 put at $2.40/contract.

I covered my MER(12.43 +0.87 +7.53%, ) short at $33.o3/share today with 12% gain because I had a $33 stop. I’ll go back in soon as what Mr. Roubini explained these brokers/dealers are screwed.

I just covered my BAC(15.05 +1.00 +7.12%, ) short  at 30.20/share ( 26% loss) to reduce my exposure to the craziness in the financial sector since I already have MER(12.43 +0.87 +7.53%, ).

I might get back into the position later if there is any new development that convince me that the trouble will hurt their business more.