I really wanted to write this post after the market closed today.  But I have been literally working on other projects for our firm for the past seven hours (11:50pm EDT now).  So I’m going to share my thoughts on what I believe is a very good risk/reward trade in Merrill Lynch.

MER issued a secondary about two weeks ago that was 38.5% dilutive to its equity holders.  What this means is that for every 100 shares of Merrill Lynch stock that was outstanding prior to the secondary offering they issued an additional 38.5 shares to raise capital to strengthen their balance sheet.  The shares were sold to investors for $22.50.

The market viewed this secondary very favorably as since the new shares were issued MER has rallied from $22 to $28.  I’ve attached two charts to illustrate the point I’m going to make.  When factoring the amount of dilution from the new shares MER has rallied a much greater percentage from its lows than other brokers (MS, LEH).

MER at $28 is the equivalent of it trading over $45 per share when factoring the dilution of the shares they have just issued.  If you look at the 3 month chart below you can see that $45 is a pretty good resistance level.  If MER were to rally to $29.50 tomorrow, which seems entirely possible based on todays price action, it will be the equivalent of it trading at $48 pre dilution.  The stock would be an unbelievably good short at that price!

Tomorrow morning I am hoping that MER breaks above 28.25 where it has failed twice in the past 8 days.  I will look for a failure between $29-$29.50.  Get short and maintain my short bias until it retraces back to $26 (at a minimum).