Today I covered my shorts in Washington Mutual (NYSE: WM) at $2.25. I shorted WaMu in April at $11.94. It is my view that the nation’s largest savings and loan institution is insolvent and deserves to fail. However, Merill Lynch, too, deserved to go bankrupt but was bought out by Bank of America at a ridiculously high premium. Could Washington Mutual similarly be taken over at a big premium? According to Britain’s Daily Mail newspaper, JPMorgan Chase is in advanced talks to buy Washington Mutual. So far no other source is confirming this story, but it can happen.

WaMu’s deposits have declined over the last few months so if any other bank finds value in the company as a whole, now is the time to buy before there is a massive run on the bank. After Bank of America offered a mind boggling premium to Merill Lynch, I am now afraid that another large premium could be forthcoming for WaMu, though I would assign a small probability to this outcome.

With the value of my WaMu short position having shrunk by 81%, I don’t stand to gain a lot more even if the FDIC proceeds with a takeover causing the stock to fall to zero. Therefore, I took profits and closed my short position to look for other shorting opportunities. I’m still short calls on WaMu which have a strike price of $10 and expire in January 2009 because I just don’t see how any possible takeover by another bank will value the stock above $10 and the options should expire worthless.