In World War I, the brutal technology of the military -- that is, the sheer velocity and power of the machines -- stunned the generals who deployed it. They simply couldn't believe that intelligence and tactics and raw courage could be defeated by the awesome power of machine guns and artillery. Even as they knew that their own machines could destroy any number of enemy, they didn't believe that their own soldiers would fall prey.
That same sense of awe and power and shock must have overcome the seasoned professionals attending the
Morgan Stanley Dean Witter tech conference last week, as they poured on the shorts, using derivatives that were simply much too powerful given the negative story they had chosen to attack.
Let's set up the battlefield. The focus, as is often the case, was
Cisco (CSCO Quote - Cramer on CSCO - Stock Picks). The bulls wanted John Chambers to say that all things were well, and that the historic guidance of 30%-to-50% growth would hold up just fine. The bears, however, wanted to hear that Cisco was more cautious going forward and was concerned about the near term. Such an implication would leave Wall Street no choice but to have to guide down numbers come the quarterly report, because all numbers are predicated on that guidance. The guidance has become the gospel for all who know the stock.
Now understand the way money is run in this country. There are plenty of hedge funds that want to go either way depending upon what Chambers tells the audience. It is not like the old days where some hear the news and others don't. Everybody hears the same thing at the same time and takes action. All aggressive money managers have the exact same playbook. (A playbook, for the uninitiated, is what coaches use when they see various setups on the field. When it is fourth and four, the playbook says bring in the punting team. When it is third and nine the playbook says you should pass, and so on. It is the rote set of actions that get put into place in response to certain situations and it is not questioned.)
Sure enough, John Chambers, the best chief executive officer in America, gets up in front of this crowd of trigger-pullers and outlines what is essentially a more cautious outlook. There is no debate that it is more cautious. It was plainly more negative than anyone in that room was looking for, save those who thought that Cisco was going to preannounce a worst-than-expected quarter, which it certainly wasn't going to do. Here is where the overly-aggressive firepower comes into play. The hedge funds figured that Chambers' words would trigger a horrendous decline in Cisco and in the rest of the tech market. They descended on Cisco in droves, buying puts on the stock in wave after wave after wave. They also played the
Nazz on the news and bought puts on the
QQQs (QQQ Quote - Cramer on QQQ - Stock Picks), the
NDX and the Mini-NDX (that is, the
MNX). These waves were all put on pretty much at the same time, because the dissemination was perfect. They picked put contracts that would expire very soon -- most likely at the end of this week -- because, what the heck, the news was going to be out immediately and when people who were not in the room got wind of Chambers' talk, they would freak out and sell. They figured the stock would get clobbered.
But nothing happened. The selling that should have materialized, according to the playbook, did materialize almost instantly, largely as an offset to the put-buying of the hedge funds. In other words, the market-makers who sold the puts to the hedge funds then banged out the stock as a hedge. Cisco, which was at 36, dropped to 34 under that pressure. The broader market sold off too, in part, again, because of the collateral pressure put on the market by the market-makers laying off the bets of NDX, QQQ and MNX put-buyers. (Again, if you are an institution and you go in and buy 1,000 puts against an index, the folks who sell you those puts can't do so naked, or unhedged. They have to turn around and sell the underlying futures or sell the stocks themselves to hedge the risk of what they sold you.)
Editor's note: This is the first installment of a three-part article. Please check out
Part 2!
Jim Cramer
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