A Billion Here, A Billion There…

This has been the year of the “billions”. It seems everywhere we turned there was talk of billions of dollars for something or another.  Billions for Fannie and Freddie, billions for the auto industry,  billions in losses for Bernard Maddoff  investors and so on and so on…Hopefully 09 won’t be the year of the” trillions”! Surely in my lifetime I don’t remember a time where  “ billion dollars” was used so frequently and in such a nonchalant manner. So, to keep things in perspective, I figured I would try to put  ” 700 billion dollars”, the amount of the so called “TARP”  into better focus.

700 billion dollars buys you the following:

35,000,000 Chevy Malibus

1,750,000,000 Apple Iphones (the latest 3G model )

 240,000,000,000 Big Macs (sign me up!)

466,000,000,000 gallons of unleaded gasoline ( at today’s “bargain” price)

And finally, the compensation  for 1 year for 46,700  CEOs.  (as per the average earnings of an S&P 500 CEO for 2007).

Happy New Year everyone!

How Low Can The Volume Go!

Volume on the NYSE today has been beyond anemic! These low volume days can be tricky and any movement can be exaggerated very quickly.  Not much in terms of headlines to focus on today and the CNBC talking heads are having a difficult time coming up with material to fill air time. Many market participants are anticipating a bit of a rally going into the last trading days of the year and into the presidential inauguration in January.  As the new administration rolls out the many economic “rescue programs”, the markets should begin to have a bit more of a bullish tone at least until the holiday shopping season retail sales figures begin to hit the wires. The 4th quarter economic results are expected to be awful as well and will dampen any overt bullishness.

The overall market mood has definitely improved a bit over the last few weeks. There is a lot of  cash on the sidelines and money managers will face a lot of pressure to get some of this cash into the market after new years. I can’t help but believe that many will look to deploy cash into multinational, large cap companies for their relative safety in anticipation of  a global economic recovery.  Again, expect a lot of choppiness especially around earnings season but the I feel strongly that the markets will begin discounting the bad news in anticipation of a recovery in the second half of 2009. Not saying we will be making any all-time highs anytime soon but, we may trade at sustained levels 15 to 20 percent above current prices by the second quarter of 2009.  

The credit markets are also  thawing and as banks make meaningful strides towards more” normal” lending patterns, the consumer should see some relief in the form of easier access to capital. Amazing how what got us into this mess in the first place is what we are counting on to get us out! My main concern coming out of this recession will be the ensuing inflation that will definitely follow this unprecedented deployment of cold hard cash by the U.S. Government.

Optimism, Pessimism and Realism

There is a very strong correlation between an individual’s personality to their trading/investments results. Overly optimistic folks tend to be what we call “Perma Bulls”, always looking for reasons, or better yet, excuses for the market to go up. On the other hand we have the overly pessimistic group who are called, you guessed it, “Perma Bears”, always looking for reasons and excuses to be pessimistic about the markets. The truth is that at some point each camp will be right and make some money. The downside is that at other times they will be wrong and loose money. Sounds like the last 10 years? You betcha. It is very difficult to go against market sentiment, but it is almost impossible to go against your own “nature”. If you tend to be an optimistic guy or gal, you may have jumped in the markets several times over the last few months by telling yourself things such as, “it can’t go lower” or “The markets will rebound in the long run”. On the other hand the pessimistic bunch continue to be sour on the markets prospects and even though these folks have made some money in the recent slide, most will not get out in time when the market does rebound and eventually give up most of their returns.  And so goes the never ending debate between the Bull and the Bear and between the optimist and the pessimist!

Now there is a third group out there and they are called “Realists”. These folks are defined by their realistic attitude towards life therefore, towards investing and trading. This bunch  include some of the most successful investors, traders and overall business people ever. Realists are not “Perma bulls” or “Perma bears”.  They instead evaluate the market, and life for that matter, for what it is. There is a time to be pessimistic and a time to be optimistic but it is always time to be realistic.

With that being said, there are many money managers who are either Perma Bulls or Perma Bears. You know the type, they always show up on CNBC and no matter how good or bad the market may be they stick to their “label” and ask you to join their side.  ” Buy now!” , “the markets will rebound” and my favorite ” There is excellent value in the market”. The Perma Bears on the other hand are a dour bunch! According to them,  armageddon is always around every corner.  Why are these managers so adamant about their positions? well it has a lot to do with the structure of most mutual funds. Unlike hedge funds that have the ability to be “Long/Short”, mutual funds have to pick one side of the fence if you will.

The Realists are a pretty boring bunch. They know that emotion is a dangerous thing when it come to investing and trading stock markets. For that reason, if I may use a sports analogy, they are able to hit consistent singles and doubles and much more often than not , miss the homerun ball.  These folks are able to define the market by a clear evaluation of the technicals and fundamentals of whatever investment or trading vehicle they are looking at and make an educated decision regarding such without letting their personality cloud their judgement.

Careful with the traps that will be laid by the Perma Bulls and Perma Bears over the next few months and resist the temptation to jump in and blindly follow either camp. The Realists will always rule the day.

When Delta Neutral Isn’t Enough

I have had several inquiries regarding the concept of Delta Neutral options strategies so I wanted to clarify one important aspect of “neutral” trading” that goes overlooked by many options traders.  The recent surge in implied volatility has confirmed that constructing Delta neutral strategies really don’t serve the purpose unless the strategy is Gamma neutral as well. Many novice traders in strategies such as Iron Condors and other neutral strategies don’t quite understand the fact that a position that may start out as  delta neutral can quickly take on directional bias ie:  directional risk , with large moves in the value of the underlying security or a spike in implied volatility. It is very important to understand the inter-relationship of delta and price or delta and vega and not just the individual aspects of any of the  “greeks”.  The deceiving aspect of delta neutral strategies is that they only account for small moves in the underlying. Many traders fail to realize that to really create a  neutral position, you have to first neutralize gamma. Delta can then be adjusted to reflect a non-directional bias in the position. It is much easier to adjust Delta after Gamma and not the other way around.

For those who have no idea what gamma is ,  gamma is what I call the “delta accelerator”.  It is a measure of how fast delta changes in response to changes in the underlying instrument. What is the use of a delta neutral strategy in an extremely volatile environment if your Gamma is not neutralized?  That is the main reason less experienced delta neutral traders go wrong and get whacked out of positions in these volatile environments.  A delta and gamma neutral strategy has a much better change of remaining neutral. Eventually, even delta and gamma neutral positions can take directional bias if the movement is large enough in the price or implied volatility of the underlying. For profitable non directional trades keep an eye on that Gamma!

Best Use Of Government Bailout Funds

What is the best use of government funds in this crisis? Job creation. That is the best way to get the recovery on track and get Americans working again and therefore, consuming again. The consumer is 70% of the economy and if the consumer isn’t on board, we will not see a meaningful recovery soon. As the U.S. Labor Dept. reported this morning,  the number of first time fillings for state unemployment  benefits jumped by 58,000 to a 26 year high of 573,000 and a number almost 60,000 more than expected by most economists. The deteriorating job market should be the main focus of the new administration and where we can get the best “bang” for our bailout bucks.  

As credit dries up, the importance of actual current earnings will be magnified over the foreseeable future. Banks are expected to continue deleveraging their balance sheets and that basically means less availability of credit to the consumer. There is continuing evidence that even current equity lines and unsecured credit lines are being aggressively cut on both businesses and individuals. Americans will have to , for example, put down larger down payments for mortgages and debt to loan ratios will be expected to be much more conservative than we have seen in recent history.

Another consequence of the current anemic job market is that skilled workers are being forced to take much lower paying unskilled positions to get by the crisis, what economists call being “underemployed”. Many out of work bankers for example, have exited the industry and are actually competing for much lower level and lower wage positions in other industries. That scenario is being played out amongst many industries and will have a definite impact on earnings growth which directly impacts spending.

The success of the jobs creation program being layed out by the Obama administration is extremely important to this recovery. The plan should not only entail creation of jobs via  infrastructure spending, but should also include incentives for new businesses, green or otherwise. As we dole out billions upon billions of  dollars to ensure viability of individual industries, a more macro approach  will get us the most important and longest lasting benefits.

Quick Market Update

The broad markets have closed for the 3rd straight day above the 30 day simple moving averages. As I have mentioned, this may point towards the recent bullish trend continuing for a bit longer into next weeks options expiration. Volatility continues to be highly elevated and the recent economic indicators point to the fact that we may not be out of the woods as far as the economy is concerned.  As President Elect Obama mentioned recently, “Things will probably get worse better they get better”.   

As the media churns out dire news day in and day out, it has gone quite “ unnoticed”  that the S&P 500 is up close to 20% from the recently set lows. Another bullish signal that there may be a slight turn in overall sentiment is the fact that commodities stocks are beginning to pick up some steam. As demand begins to creep up again in China and other emerging markets, we may very well get a helping hand in getting out of this recession.  It is clear that overall sentiment regarding the steps outlined by President Elect Obama have also had a positive psychological effect on sentiment. As I mentioned before, this crisis has been mostly a crisis of confidence in the american financial system and good leadership is crucial to getting us out of this mess.

We continue to monitor our two remaining open positions which are showing excellent profits and well within our ranges. It is a great feeling when Theta begins to pick up steam towards expiration ( and you are on the right side of  a trade)!

Markets Rally Despite Terrible Jobs Data

Did someone forget to remind the stock market that the jobs data released this morning is the worst since December of 1974?  November brought us extremely dire news of 500,000 plus lost jobs and an  unemployment rate of 6.7%. Yet the markets seems to have digested the news relatively well and today’s  rally may point to a  mild uptick in stocks heading into year end as investors  bottom fish for beat down stocks. With the jobs report behind us, the market can look towards the next important event on the economic calender, the Federal Reserve  meeting on interest rate policy on December 15th and 16th.  Consensus seem to  point towards yet another interest rate cut possibly bringing the target fed funds overnight lending rate to .50% , the lowest level ever for this key rate.

The market action today seems to point to a stock market that has priced in the current state of the economy and is comfortable at the recently established lows. Obviously that may very well not be the case if the economy manages to get substantially worse from these levels, which it more than likely will do in the next quarter.  Again the market’s sustained levels of volatility still to point to rocky days ahead but for the immediate future we may hold these levels and actually grind a little higher. The resistance levels are very clearly drawn in the sand at around 9200 on the Dow and around 940 on the S&P 500.

Again as I have mentioned before it is extremely important to see the levels of implied volatility back off from these sustained highs. The VIX,  which is basically an indicator of fear amongst market participants based on the levels of put buying on the S&P 500, has hovered at extremely high levels for the better part of 2 months and until we see that back off to lower sustained levels, we will still be on a very steep roller coster ride.

Has Anyone Seen The Investor?

If you are wondering why the markets seem to have gone “haywire” over the past several months, you are not alone. It has been one head fake after another and as volatility continues to remain at incredible levels, investor’s appetite for stocks has waned tremendously. Even in the face of “extraordinary” bargains as many pundits put it, investors have shied away from market exposure. Well, can we blame them? 700 points up one day 700 down the next… Many Americans feel the risk reward ratio of stock investing is just too steep these days and many have opted to park cash on the sidelines. Many are receiving 401K statements that show steep losses and are opting to move funds to safe US. Treasury funds and money markets. 

So who is making money in these markets? short term momentum stock traders and options strategists especially those who employee strategies that take advantage of the elevated volatility levels. These unheard of intra day moves have made many traders an awful lot of money lately. Buy something at 10AM and sell it at 3:00PM. Short the financial in the morning buy them back in the afternoon…even lousy traders have been able to make some money in this market!

Much like the fact that our economy is primarily based on consumer spending, the market’s long term viability is very much tied to the retail investor. If the school teacher, police officer or nurse who allocates a portion of their income to their 401k’s every month, decide to pull their money from stock funds because they feel as though they are being “cheated” by professional market participants, we may have a bigger problem than the current recession. If the markets don’t find some stability soon, the only ones left trading will be the pros and long term that is not good for anyone.

Market Week Ahead 12/01/08

Last week, the S&P 500 climbed 12%, the Dow industrials rose 9.2% and the Nasdaq Composite rose 11%.

The retail industry got mixed reviews for Black Friday in that shoppers spent about 7% more than last year but looked for deeply discounted merchandise which affects overall profitability.  

The economic calender takes off Monday with ISM data ( Institute of Supply Management) which will gauge November’s manufacturing activity. Most economists believe the data will post its worst reading since 1982.

Both Federal Reserve Chairman Ben Bernanke  and Treasury Secretary Henry Paulson are due to give an update on the U.S. economy and markets. The saga concerning the automakers will continue and will take up the headlines early in the month and will have an impact on any year end rally.

 

The trading week apparently will start with a pullback by the indication of the futures and I believe that is to be expected after 5 days running of gains in all major averages. Volatility should continue to raise its ugly head and we may see some volatile swings in intraday trading. We are still of the opinion that we will drop a bit this week and possibly next before staging a bit of a rally going into year end.