The gap between what the Fed provides the banks and how the banks provide money to the consumer is becoming bigger and bigger. The Fed rates are cut but they are overnight lending rates and hence the banks are borrowing more cheap money AND hoarding the liquidity provided from other sources the Fed.
In other words, banks which are supposed to lend CONSUMERS money to grease the flow of goods and services are NOT doing that since they are afraid they will go out of existence. It is perfectly rational for banks to do so. Additionally, the banks are concerned that people who have lost their jobs, have seen the value of their houses drop a lot, have no health insurance, and have to send kids to college will not be the best parties to lend to....
So the bank has to charge such people a higher rate of interest AND lend them less money....
All this above is the reason why the real economy will suffer quite badly. Also, there are many illiquid assets, the effect on which is not felt quickly. The losses are NOT all fully realized. So I think there will be more pain to come.
How to Trade this?
I like buying puts - Dec 08 750 strikes. May consider selling 1150 calls to fund it ( same maturity). The way I like to do it is to put in a limit order and wait for the market to reach my price. If I don't get it at the price I wanted I don't trade since I don't have enough time to monitor...
Thursday, October 30, 2008
Tuesday, October 28, 2008
Mr. Kipling
This seems oddly fitting ....
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you
But make allowance for their doubting too,
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:
If you can dream--and not make dreams your master,
If you can think--and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build 'em up with worn-out tools:
If you can make one heap of all your winnings
And risk it all on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on!"
If you can talk with crowds and keep your virtue,
Or walk with kings--nor lose the common touch,
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much,
If you can fill the unforgiving minute
With sixty seconds' worth of distance run,
Yours is the Earth and everything that's in it,
And--which is more--you'll be a Man, my son!
If you can keep your head when all about you
Are losing theirs and blaming it on you,
If you can trust yourself when all men doubt you
But make allowance for their doubting too,
If you can wait and not be tired by waiting,
Or being lied about, don't deal in lies,
Or being hated, don't give way to hating,
And yet don't look too good, nor talk too wise:
If you can dream--and not make dreams your master,
If you can think--and not make thoughts your aim;
If you can meet with Triumph and Disaster
And treat those two impostors just the same;
If you can bear to hear the truth you've spoken
Twisted by knaves to make a trap for fools,
Or watch the things you gave your life to, broken,
And stoop and build 'em up with worn-out tools:
If you can make one heap of all your winnings
And risk it all on one turn of pitch-and-toss,
And lose, and start again at your beginnings
And never breath a word about your loss;
If you can force your heart and nerve and sinew
To serve your turn long after they are gone,
And so hold on when there is nothing in you
Except the Will which says to them: "Hold on!"
If you can talk with crowds and keep your virtue,
Or walk with kings--nor lose the common touch,
If neither foes nor loving friends can hurt you;
If all men count with you, but none too much,
If you can fill the unforgiving minute
With sixty seconds' worth of distance run,
Yours is the Earth and everything that's in it,
And--which is more--you'll be a Man, my son!
Thursday, October 9, 2008
the worst 81% return in a day of my life
So I have been short the S&P for a while betting on the fact that volatility will shoot up massively and increase the values of highly leveraged puts. ...This is indeed what has happened... VIX, the volatility index has jumped to levels unheard of ( at 63 as compared to sub 10 in 2007 and levels of mid 20s most times) and I made a big return. However, my HUMAN CAPITAL is tied to the market and I am REALLY worried about a recession now... 7% index drops in U.S. markets on successive days are jumps no one had really modeled before.
This is the environment when GAMMA pays even though it is expensive i.e. better to be LONG options than short....
volatility, jump risk, inflation and fear premia are back
This is the environment when GAMMA pays even though it is expensive i.e. better to be LONG options than short....
volatility, jump risk, inflation and fear premia are back
Wednesday, October 8, 2008
All the King's men...
Couldn't put the economy back together again.
The Fed has thrown everything at the crisis and still the s&P closes below 1000. These are BAD times...
I still like the short EUR And GBP trade but more against the Yen (JPY) than against the dollar... simply because the Fed will cut more than the ECB AT the moment. Thus I expect a temporary bounce in EURUSD but later on for EURUSD to tank again as Europe's problems come to the fore...
The Fed has thrown everything at the crisis and still the s&P closes below 1000. These are BAD times...
I still like the short EUR And GBP trade but more against the Yen (JPY) than against the dollar... simply because the Fed will cut more than the ECB AT the moment. Thus I expect a temporary bounce in EURUSD but later on for EURUSD to tank again as Europe's problems come to the fore...
Tuesday, October 7, 2008
Close End Funds get hammered!- That's Illiquidity and info. asymmmetry for you
In September, the median discount for all closed-end funds
(CEFs) widened an amazing 687 basis points (bps) to 16.05% (the largest overall end-of-month discount in over ten years), almost doubling the 12-month average of 8.46%.
- The global credit crisis and recent failure of supportive legislation led to dramatic declines in equity CEFs (-13.22%) and fixed income CEFs (-8.31%) returns for the month of September, and the lot cumulatively posting a minus 10.14% return on a NAV basis.
- On the stock side Domestic Equity Funds (-10.89%) and World Equity Funds (-14.35%) mitigated losses better than their Mixed-Equity Funds (-19.15%) counterpart.
- For the month only 13 funds were able to post plus-side returns, leaving 668 funds underwater and one at the breakeven mark.
- The Income & Preferred Stock Funds (-21.12%) classification posted the worst return in the CEF universeMonday, October 6, 2008
USDJPY has screamed down to 100, Dow down to 9612 and S&p to 1015
The world looks quite bleak...There is REAL panic now and I fully expect a global recession over the next two years
I was somewhat wrong about USDJPY not trading outside of 101/109 levels.... This is a massive vote of no confidence by the markets... I think this is Europe and Britain having crises that is being priced in....I still hope USDJPY bounces back and it is impressive that USDJPY didn't break 100 even with VIX above 52, however it doesn't mean it wouldn't
I still like the following trade
Short EUR, GBP ( against USD and JPY)....
I was somewhat wrong about USDJPY not trading outside of 101/109 levels.... This is a massive vote of no confidence by the markets... I think this is Europe and Britain having crises that is being priced in....I still hope USDJPY bounces back and it is impressive that USDJPY didn't break 100 even with VIX above 52, however it doesn't mean it wouldn't
I still like the following trade
Short EUR, GBP ( against USD and JPY)....
Sunday, October 5, 2008
Long USD vs. short GBP and EUR
The current crisis is quite interesting- both academically as well as personally, although I suspect most people would change the order of my adjectives.
First of all, the trades
I have been long the dollar for a while against the EUR and GBP and I continue to like the trade- Euroland will face its first recession and two things will weigh upon it: first, the survival of Euroland as an entity is doubtful, the second the extent of the problem is not being realized fully and Trichet and co. always lag the US in monetary policy. While the first reason doesn't apply to GBP, the second does. British banks will have a pretty rough time in the coming few months in my view.
I think USDJPY doesn't move too much from here. I would say it remains rangebound between 101- 109 over the next month. Obvioulsy you can buy leveraged Double Knockout etc. Or you can range trade with spot- say USDJPY goes to 108, then go short and if USDJPY goes to 102, go long.
S&P has broken 1100 levels and it is interesting that this is AFTER the bailout package was passed! VIX- the measure of 1m implied volatility for the S&P (roughly speaking) has been at 45 levels for a week. Normally, VIX is used as a gauge of fear over the next month. I think the correct way to look at VIX is fear + expectation of movement. ( In acacdemic jargon, the expected realized volatility + volatility risk premium). The reason VIX is at 45 -levels rarely seen and ones close to Aug 1998 crash is because now, like then, we are uncertain about the direction of indices as well as afraid.... Believe it or not it is possible for
VIX to remain at 45 levels for a while.
I think VIX at these levels shows that investors are afraid of what will happen and there is doubt about the Fed's ability to control the outcome at this point and that is what makes us afraid. If the biggest Central Bank cannot control this, then we are screwed... buy GOLD and hide money in your mattresses scenario comes to mind.
I don't think that we should be so pessimistic but the Fed IS doing some strange things so it is hard to blame the market. The market just reflects what the people participating in the market believe.
Good Luck!
First of all, the trades
I have been long the dollar for a while against the EUR and GBP and I continue to like the trade- Euroland will face its first recession and two things will weigh upon it: first, the survival of Euroland as an entity is doubtful, the second the extent of the problem is not being realized fully and Trichet and co. always lag the US in monetary policy. While the first reason doesn't apply to GBP, the second does. British banks will have a pretty rough time in the coming few months in my view.
I think USDJPY doesn't move too much from here. I would say it remains rangebound between 101- 109 over the next month. Obvioulsy you can buy leveraged Double Knockout etc. Or you can range trade with spot- say USDJPY goes to 108, then go short and if USDJPY goes to 102, go long.
S&P has broken 1100 levels and it is interesting that this is AFTER the bailout package was passed! VIX- the measure of 1m implied volatility for the S&P (roughly speaking) has been at 45 levels for a week. Normally, VIX is used as a gauge of fear over the next month. I think the correct way to look at VIX is fear + expectation of movement. ( In acacdemic jargon, the expected realized volatility + volatility risk premium). The reason VIX is at 45 -levels rarely seen and ones close to Aug 1998 crash is because now, like then, we are uncertain about the direction of indices as well as afraid.... Believe it or not it is possible for
VIX to remain at 45 levels for a while.
I think VIX at these levels shows that investors are afraid of what will happen and there is doubt about the Fed's ability to control the outcome at this point and that is what makes us afraid. If the biggest Central Bank cannot control this, then we are screwed... buy GOLD and hide money in your mattresses scenario comes to mind.
I don't think that we should be so pessimistic but the Fed IS doing some strange things so it is hard to blame the market. The market just reflects what the people participating in the market believe.
Good Luck!
Wednesday, October 1, 2008
What the crisis has to teach traders AND my view on the bailout
This crisis is teaching a very valuable lesson to traders; you can't rule anything out! For instance many people assumed that the "bailout bill" would be passed... and it wasn't. I was totally shocked and I think most of the market participents were also.
Why do such extreme movements mostly destroy capital
It would seem that in a "zero sum game" of day trading capital should be preserved- i.e. if someone bet on the bill not being passed out then they should have made boatloads of money, equal in amount to the money that other people who were depending on the bill being passed lost.
Sometimes it does work the way people think. Other times, when the movements are too extreme - first one way and then the other way, BOTH parties can end up bankrupt! Say the market starts at 100 - goes to 50 and then comes back to 150. The person who was "long" i.e. had bought the market should make 50 units (150-100) however if that person cannot meet the margin call at 50 he will get liquidated and will have nothing to trade when the market does rise. Thus trading becomes PATH DEPENDENT. There are almost no path independent securities! Path dependent means that the overall profits realized don't depend only on the final and initial values but also on the path taken.
My view on the bailout plan:
I like the bail out plan in its current form a bit better. One of the issues is how exactly do we propose to value the complex securities. The second one is moral hazard that the banks who rolled the dice will do it again...
I think destroying equity value and preserving the bond value will be a decent answer to the moral hazard. In other words if the banks who rolled the dice are told- ooops bad outcome it means you go bankrupt (slowly), or are acquired AND your CEO gets fired... other bank won't do this in the future. However, by insuring that money market accounts ( who buy the bonds) don't go under , the "Main street" will be safe as people's deposits won't be taken away from them and the credit crunch won't be as bad. Just imagine the consequences of no one accepting credit cards anymore...... or bank checks or whatever> we are back to barter and cash :)...
Valuing complex securities... perhaps we have an auction where banks can bid on it.. the market is always a better determinant of prices than individuals (even the Fed!)
Why do such extreme movements mostly destroy capital
It would seem that in a "zero sum game" of day trading capital should be preserved- i.e. if someone bet on the bill not being passed out then they should have made boatloads of money, equal in amount to the money that other people who were depending on the bill being passed lost.
Sometimes it does work the way people think. Other times, when the movements are too extreme - first one way and then the other way, BOTH parties can end up bankrupt! Say the market starts at 100 - goes to 50 and then comes back to 150. The person who was "long" i.e. had bought the market should make 50 units (150-100) however if that person cannot meet the margin call at 50 he will get liquidated and will have nothing to trade when the market does rise. Thus trading becomes PATH DEPENDENT. There are almost no path independent securities! Path dependent means that the overall profits realized don't depend only on the final and initial values but also on the path taken.
My view on the bailout plan:
I like the bail out plan in its current form a bit better. One of the issues is how exactly do we propose to value the complex securities. The second one is moral hazard that the banks who rolled the dice will do it again...
I think destroying equity value and preserving the bond value will be a decent answer to the moral hazard. In other words if the banks who rolled the dice are told- ooops bad outcome it means you go bankrupt (slowly), or are acquired AND your CEO gets fired... other bank won't do this in the future. However, by insuring that money market accounts ( who buy the bonds) don't go under , the "Main street" will be safe as people's deposits won't be taken away from them and the credit crunch won't be as bad. Just imagine the consequences of no one accepting credit cards anymore...... or bank checks or whatever> we are back to barter and cash :)...
Valuing complex securities... perhaps we have an auction where banks can bid on it.. the market is always a better determinant of prices than individuals (even the Fed!)
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