March 2012

Is an Apple Short the Trade of the Year?

When Apple (AAPL) made its three day, $50 move up last week, it created $55 billion in new market capitalization. That 72 hour addition alone would rank it as the 100th largest company in the world besides Boeing (BA), Union Pacific Railroad (UNP), and Nike (NKE). Trading volume in Apple calls is has smashed all records. The action has been more frenzied than seen in any single name since the height of the dotcom bubble 12 years ago.

I tried to take a bite out of Apple, selling 20% deep out of the money, front month calls. It looked clever for exactly two weeks. Instead, Apple took a bite out of me. When the appreciation suddenly accelerated on no news specific to Apple, implied volatility for the options popped from 30% to 40% in an hour, and I got stopped out.

Moves like this are unprecedented in the history of the options market. I know people who are doubling their money every week, buying out of the money Apple weekly calls, and rolling their way all the way up, knowing full well that their last trade will result in a total loss.

So that got me to thinking. Is the greatest shorting opportunity of the year setting up here? I started playing around with some numbers when Steve Jobs? creation hit $600 a share yesterday. I looked at the April, 2012 put series, which expire in 25 trading days, on April 20. Then, the $500 puts were trading at $2.00. What would happen if the stock fell? I did some back of the envelop calculations and came up with the following:

Apple Option
Fall??? Price?????? % Gain
$10??? $2.50???????? 25%
$20??? $3.25???????? 62%
$30??? $4.50???????? 125%
$40??? $6.00???????? 300%
$50??? $8.00???????? 400%
$60??? $10.50?????? 425%
$70??? $13.75?????? 587%
$80??? $17.75?????? 787%
$90??? $22.25?????? 1012%
$100? $27.50?????? 1275%

I thought ?well, that?s pretty interesting?, and set to write up a Trade Alert to buy the $500 puts. But by the time I finished writing it, Apple fell $25 and the puts doubled. I missed the entry point so I decided to wait.

I love Apple stock, and it now looks like it will hit my long term $1,000 target sooner than later. I have been filling up my house with Apple gadgets as fast as I can, like everyone else, picking up an iPhone, a MacBook Pro, and a MacBook Air. The ecstatic people on TV this morning piling into Apple stores at the crack of dawn to buy the new iPad behave like they?re just won the lottery.

But I also know what a parabolic stock move looks like on the charts, and I have never seen them end in anything but tears. At some point they end, falling back down to a trend line, even if that trend remains up. The volume on the downside is even greater than on the upside. I image that quite a lot of the recent buying has been on margin or with huge leverage. Apple stock is cruising for a bruising, and no one would be surprised to see a sudden $100 sell off.

I?ll tell you when to put on this trade. Wait for the next three day, $50 spike, and then commit 1% or 2% of your capital, no more. You are looking to risk 1% to make 10%, not 100% to make 1,000%. I frequently get resumes from those who tried the later and are now unemployed, and believe me, you don?t want to try this.

Of course, it is possible that the final $50 spike is behind us, in which case this entire discussion has been academic. But it is still a good exercise to carry out to learn what is possible. And since St. Patrick?s Day is upon us, you might want to down a quick shot of Irish whiskey first, neat, if you end up doing the trade.

Sign of a Top?

Watch Out for the Millennial Voter

Diary

I have been banging the table for years now about the importance of demographic trends for the economy, the financial markets, and the housing market. Well, politics is no different.

According to recent surveys, Millennials, who are now aged 19-30 (I have three of them) are suspicious of government, have a strong anti-business bias, are opposed to new regulation, are highly conscious of environmental issues, and give the president his highest marks. They also happen to care the least about health care, and put a high value on ethics. We also have learned that they don't bother to vote in midterm elections. This is important because the Millennium Generation surpassed in size 80 million strong baby boomer generation last year.

No wonder the last election focused so much energy on online campaigning and social media. Is the outcome of future elections to be determined by clicks and bandwidth? The data effectively means that the population of liberals is growing, while that for conservatives is shrinking. Politician planners and makers of campaign tchotchke take note.

March 19, 2012 - Quote of the Day

Quote of the Day

?I don?t like the bond market at all. A jackass in a Tuxedo is still a jackass,? said Bill Spiropoulis at Corestates Capital Advisors

The New Carry Trade

Diary

Long the domain of hedge funds and large banks, the carry trade has gone mainstream. Individual investors are increasingly resorting to the techniques employed by the masters of the universe to boost trading and investment returns.

But they lack the risk control infrastructure and discipline employed by the big boys. As with other innovations of yore, the net result has been to build up more risk in the system than many realize. This always ends in tears, not just for the players, but for everyone.

The ?carry trade? is just another way of buying low and selling high and doing both at the same time. In its newest incarnation, retail investors borrow cheap overnight money from their discount brokers and invest in high dividend paying stocks. Favorite targets have included REIT?s, tobacco, and utilities. They then use broker margin facilities to double up the bet. Large individual players can obtain private credit lines that increase leverage even further.

Let me give you an example with one of the favorite target stocks, Altria (MO), the old Phillip Morris. The dividend yield today is 5.40%. Take out the 2% cost of funds provided by online broker TD Ameritrade, and that brings the net down to 3.40%. Double is up with margin and it rises to 6.80%. In a zero return world that is quite a pick up. This is no doubt why the stock has risen 20% since October, bringing the total return up to 26.80%.

There is only one problem with this picture. What happens when the stock goes down? Leveraged positions are subject to margin calls, whether the customer is willing or not. While there is abundant margin in rising markets, it has the habit of disappearing of disappearing in falling ones. Read the fine print in your margin agreement and you will find that your friendly broker has the right to call in their loans at any time without notice.

They have a long history of doing this after sharp selloffs, right when distress is the greatest. Many traders only find this out when they get an email telling them their entire position has been liquidated at market. I can tell you from hard earned experience that there is no person in the world more blind to reason that a margin clerk.

Bunch up a lot of liquidations of these carry trades and you could throw gasoline on any fires that ignite during a market correction. Who might provide the matches? The government, which is expected to substantially raise taxes on dividends after the next election. High dividend stocks that were last year?s stars could become this year?s goats. Be careful that your carry trade doesn?t carry you out.

Will High Dividend Stocks Become This Year?s Goats?

Conspiracy Theory of the Day

Diary

A confidential report from the Pentagon just made public says that the 2008 financial crisis was the result of targeted attacks by terrorists groups. A ramp up of oil prices that began in 2007 led to the bear raids against Bear Stearns and Lehman Brothers in 2008. The final phase may be in place now, forcing the US to engage in massive and unsustainable borrowing to cope with the Great Recession that followed. The consequent collapse of the dollar is assured.

Two firms, left anonymous in the report, were particularly aggressive in the execution of this plan, which engaged in highly leveraged purchases of credit default swaps and the shorting of stocks. It is believed they were acting as agents on behalf of unnamed enemies of the US. Was it China? Jihadists? Or Goldman Sachs (GS)?

I know that parties with advanced knowledge of the 9-11 attacks bought a massive position in American Airlines puts just days before, which they executed through Swiss banks. They never collected a windfall profit thought to exceed $200 million, as the FBI was ready to pounce. So we know that at least terrorist friends are active in the market in big size.

However, this report sounds more like a John le Carre novel than having any bearing in reality. Did terrorists force Alan Greenspan to keep interest rates artificially low? Did they intimidate millions of subprime borrowers into taking out loans they could never repay. Did terrorists drug the SEC, putting them to sleep while bankers ran wild? Did Chinese agents lobby for the repeal of Glass Steagle?

I doubt it. It all sounds like a fantasy that squeezed through the cracks on a slow news day. I think the Pentagon better stick to their day job of blowing up stuff rather than analyzing financial markets.

Was This a Trading Strategy?

Why Warren Buffet Hates Gold

Diary

The 'Oracle of Omaha' expounded at length today on why he despises the barbarous relic. The sage doesn't really care about the yellow metal, whatever the price. He sees it primarily as a bet on fear.

If investors are more afraid in a year than they are today, then you make money. If they aren't, then you lose money. If you took all the gold in the world, it would form a cube 67 feet on a side, worth $7 trillion. For that same amount of money, you could own other assets with far greater productive power, including:

*All the farmland in the US, about 1 billion acres, which is worth $2.5 trillion.

*Seven Apple?s (AAPL), the largest capitalized company in the world.

*You would still have $2 trillion in walking around money left over.
Instead of producing any income or dividends, gold just sits there and shines, letting you feel like you are King Midas.

I don't know. With the stock market peaking around here, and oil trading at $105/barrel, a bet on fear looks pretty good to me right now. I'm still sticking with my long term forecast of the old inflation adjusted high of $2,300/ounce. But we may have to visit $1,500 on the way there first.

Maybe Feeling Like King Midas is Not So Bad

March 16, 2012 - Quote of the Day

Diary

?What the wise man does in the beginning the fool does in the end,? said oracle of Omaha, Warren Buffett.

Is the Fat Lady Singing for the Treasury Bond Market?

Diary

With global quantitative easing now getting long in the tooth, I think the party is about to end for the Treasury bond market. For the last four months, this market has been stuck in a tedious, narrow range, with ten year paper stuck between a 1.90% - 2.10% yield. Trading bonds has been as exciting as watching paint dry, with only professionals able to engineer profitable round trips. The charts below show that we have at last broken out of that range.

Private US investors and foreign central banks are not going to be able to make up the shortfall in bond buying once the Fed and the ECB exit the stage. The big problem is that the bond market these days is very much like a Ponzi scheme. Unless there is a steady inflow of new suckers, the entire plan collapses like a house of cards.

I can?t tell you how many hedge funds are itching to short Treasury bonds. Thousands jumped in too early last year only to get their fingers burned, myself included.

The ideal instrument for the individual investor to get involved in this market is with is the ProShares Ultra Short 20+ Treasury ETF (TBT). I have included a three year chart below to show you what the long grinding bottom looked like. The only surprise is that it took this long to turn up, given the strength we have seen in risk assets since October.

Keep in mind that the cost of admission to play this game is high. A 200% short bond position means that you are short the coupon twice. For a 30 year bond with a 3.4% yield, that adds a cost of carry of 6.8%. Add in another 1.2% for management fees, expenses, and other hidden costs, and you really need Treasury bonds to fall 8% year just to break even in the ETF. You won?t ever see the interest and fees deducted. It just feeds directly into the ETF price. On top of that, you can expect some tracking error. That?s why it is best to catch only the short term pops in this security, much like you have seen this week.

Of course, I hate buying anything that has just popped 10%. You know me, I am not a chaser. Ideally, the long awaited 5% correction in stocks will create a rally in bonds and a selloff in the (TBT) that could provide a prudent entry point.

If this really is the end of the 30 year bull market, there is a lot of room on the upside for the (TBT). Take 30 year yields back to last year?s high of 4.2%, and the (TBT) nearly doubles to $40. If the markets want to finally pay attention to our large and ballooning budget deficits, now over 100% of GDP, it could deliver a multiple of that.

Is the Fat Lady Singing for the Treasury Market?

The Structural Bear Case for Treasury Bonds

Newsletter

If you want to delve into the case against the long term future of US Treasury bonds in all their darkness, take a look at Foreign Affairs, the establishment bimonthly journal read by academics, intelligence agencies, and politicians alike, which I am sure you all have sitting on your nightstands. In a well-researched and thought out article penned by Roger C. Altman and Richard N. Haas, the road to ruin ahead of us is clearly laid out.

The US has no history of excessive debt, except during WWII, when it briefly exceeded 100% of GDP. That abruptly changed in 2001, when George W. Bush took office. In short order, the new president implemented massive tax cuts, provided expanded Medicare benefits for seniors, and launched two wars, causing budgets deficits to explode at the fastest rate in history. To accomplish this, strict ?pay as you go? rules enforced by the previous Clinton administration were scrapped. The net net was to double the national debt to $10.5 trillion in a mere eight years.

Another $4.5 trillion in Keynesian reflationary deficit spending by president Obama since then has taken matters from bad to worse. The Congressional Budget Office is now forecasting that, with the current spending trajectory and THE 2010 tax compromise, total debt will reach $23 trillion by 2020, or some 160% of today?s GDP, 1.6 times the WWII peak.
By then, the Treasury will have to pay a staggering $5 trillion a year just to roll over maturing debt. What?s more, these figures greatly understate the severity of the problem. They do not include another $9 trillion in debts guaranteed by the federal government, such as bonds issued by home mortgage providers, Fannie Mae and Freddie Mac. State and local governments owe another $3 trillion. Double interest rates, a certainty if commodity price inflation continues unabated, and our debt service burden doubles as well.

It is unlikely that the warring parties in Congress will kiss and make up anytime soon, especially if we get another split congress after the November election. It is therefore likely that the capital markets will emerge as the sole source of any fiscal discipline, with the return of the ?bond vigilantes? to US shores after their prolonged sojourn in Europe. They have already made their predatory presence known in the profligate nations of Europe, and they are expected to arrive here eventually.

Such forces have not been at play in Washington since the early 1980?s, when bond yields reached 13%, and homeowners paid 18% for mortgages. Since foreign investors hold 50% of our debt, policy responses will not be dictated by the US, but by the Mandarins in Beijing and Tokyo. They could enforce a cut back in defense spending from the current annual $700 billion. They might even demand a retreat from our $150 billion a year commitments in Iraq and Afghanistan.

Personally, I think the US will never recover from the debt explosions engineered by Bush and by ?deficits don?t count? vice president Chaney. The outcome has permanently lowered standards of living for middle class Americans and reduced influence on the global stage.

But don?t get mad about our national debt debacle, get even. Make a killing profiting from the coming collapse of the US Treasury market through buying the leveraged short Treasury bond ETF, the (TBT). Just pick your entry point carefully so you don?t get shaken out in a correction.

Looks Like I Can?t Afford the Next War

March 15, 2012 - Quote of the Day

Diary

?At these prices, bonds should have warning labels on them,? said Doug Kass of Seabreeze Partners.