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Morning Update

Overnight risk sentiment in Asia and Europe was buoyed by a strong PMI out of China. Japanese data was weaker than expected, confirming an accelerating recession in the country. Then Yen has been strong though after hitting major support levels against the Australian and US dollars and ahead of Japanese elections this weekend. This morning the US CPI posted its biggest decline in 6 months but industrial production topped even the highest estimates. With congress at home for the weekend Fiscal Cliff headlines, which control the market right now, are likely to be muted today, leaving only the market technical to fuel trading. The S&P 500 futures are currently at their 50 day moving average, which should provide some support.If Fiscal Cliff fears to surface, I would expect to see the Jan. VIX contract, which has been under performing the Dec contact, catch a bid.

Yesterday MetLife issued a warning to investors that next year’s earnings could come in less than analysts are expecting and below its prior guidance. This sent shares down 2.3% but did not deter some bullish option trades. The biggest trade of the day was the purchase of 9473 March 37 calls for $0.58 with the stock at 32.92. This trade will profit if MET is above 37.58, 14% higher, in the next 91 days.

MetLife’s announcement said that they now expect operating earnings of $4.95 - $5.35 in 2013, would take a $800MM charge in the fourth quarter, and do not expect to buy back stock in 2013. Operating earnings are expected to decline due to the company’s struggle with the current low interest rate environment. Next year the company expects to reduce its sales of variable annuities with guarantees of lifetime income as baby boomers, worried that they will outlive their savings, rush to buy them. These products are not as profitable as they used to be because they are capital intensive and low interest rates make hedging difficult. This is a sign that MetLife is shifting its focus into more profitable, higher margin businesses. In order to further reduce capital requirements and decrease regulatory scrutiny, MetLife announced that it was conditionally approved to sell $6.5B of its bank deposits to GE in move to get rid of its bank holding company status. Once MetLife has sold its bank it will not be subject to stress tests and will be able to buy back shares more easily.

Though this announcement was bearish in the short term, it shows that MetLife positioning itself for long term growth. CEO Steven Kandarian stressed that although share buybacks were not likely in 2013, they would be in future years. MetLife currently trades at 60% of its book value and has a dividend yield of over 2%. Once the company gets through Q4 and investors become more comfortable with the idea of slower growth in 2013 for strong growth in 2014 and beyond, the stock could begin to rally towards book value. Since the stock could see near term volatility ahead of Q4 earnings I would not buy the stock now, and opt for the fixed risk profile of a call option. If, at March expiration, MET has rallied and is above 37 the trade will be profitable and you will have the option to buy the stock there and hold it for continued profits.

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