Mad Hedge Technology Letter
October 16, 2019
Fiat Lux
Featured Trade:
(IS 3D PRINTING A WASTE OF SPACE?)
(SSYS), (ETSY), (MSFT), (BA), (NFLX), (GE), (LMT)
With stock market volatility greatly elevated and trading volumes through the roof, there is a heightened probability that your short options position gets called away.
If it does there, is only one thing to do: fall down on your knees and thank your lucky stars. You have just made the maximum possible profit on your position.
Most of you have short options position, although you may not realize it. For when you buy an in-the-money call option spread, it contains two elements: a long call and a short call. The short call can get assigned or called away at any time.
You have to be careful here because the inexperienced can blow their newfound windfall if they take the wrong action, so here’s how to handle it.
The 5:30 AM phone call was as shrill as it was urgent.
A reader had employed one of my favorite strategies, buying the Microsoft (MSFT) November 2018 $90-$95 in-the-money vertical call spread at $4.50.
He had just received an email from his broker informing him that his short position in the (MSFT) November $95 calls was assigned and exercised against him.
He asked me what to do.
I said, “Nothing.”
For what the broker had in effect done is allow him to get out of his call spread position at the maximum profit point 20 days before the November 16 expiration date.
All he had to do was call his broker and instruct him to exercise his long position in his November $90 calls to close out his short position in the $95 calls.
Calls are a right to buy shares at a fixed price before a fixed date, and one option contract is exercisable into 100 shares.
In other words, he bought (MSFT) at $90 and sold it at $95, paid $4.50 cents for the right to do so, his profit is 50 cents, or ($0.50 X 100 shares X 22 contracts) = $1,100. Not bad for a nine-day limited risk play.
Sounds like a good trade to me.
Weird stuff like this happens in the run-up to options expirations.
A call owner may need to sell a long stock position right at the close and exercising his long November $95 calls is the only way to execute it.
Ordinary shares may not be available in the market, or maybe a limit order didn’t get done by the stock market close.
There are thousands of algorithms out there, which may arrive at some twisted logic that the puts need to be exercised.
Many require rebalancing of hedges at the close every day, which can be achieved through option exercises.
And yes, calls even get exercised by accident. There are still a few humans left in this market to blow it.
And here’s another possible outcome in this process.
Your broker will call you to notify you of an option called away, and then give you the wrong advice on what to do about it.
This generates tons of commissions for the broker, but is a terrible thing for the trader to do from a risk point of view, likely generating a loss by the time everything is closed and netted out.
Avarice could have been an explanation here, but I think stupidity, poor training, and low wages are much more likely.
Brokers have so many ways to steal money legally that they don’t need to resort to the illegal kind.
This exercise process is now fully automated at most brokers, but it never hurts to follow up with a phone call if you get an exercise notice. Mistakes do happen.
Some may also send you a link to a video of what to do about all this.
If any of you are the slightest bit worried or confused by all of this, come out of your position RIGHT NOW at a small profit! You should never be worried or confused about any position tying up YOUR money.
Professionals do these things all day long, and exercises become second nature, just another cost of doing business.
If you do this long enough, eventually you get hit. I bet you don’t.
If you need a new investment theme – here’s one.
3D printing.
Yes, the same 3D printing that was once considered a raging but hopeless fad.
A lot has changed since then.
Early adopters were largely cut down at the knees as they tried to traverse the rocky terrain from a niche market to going full out mainstream.
Production complications and the lack of specialists in the industry meant that problems were rampant and nurturing an industry from scratch is harder than you think.
Believe me, I’ve been there and done that.
It is time to stand up and take notice of 3D printing, this time it is here to stay.
Certain tech companies love this technology like e-commerce company Etsy (ETSY) who focuses on personalized handcrafts.
The cost of production doesn’t change whether you’re producing one item or a million because of the economies of scale.
The previous 3D printing bonanza was a frenzy and this corner of tech became known for the use of buzzwords representing the potential to reinvent the world.
With lofty expectations, there was a natural disappointment when outsiders understood growing pains were part of the critical evolution instead of a direct route to profits.
The initial goal was to democratize production which sounds eerily similar to bitcoins mantra of democratizing money.
The way to do this was to make it simple to produce whatever one wishes.
That would assume that the general public could pick up professional production 3D printing skills on arrival.
That was wishful thinking.
The truth was that applying 3D printers was tedious.
Issues cropped up like faulty first-generation hardware or software -problems that overwhelmed newbies.
Then if everything was going smoothly on that front, there was the larger issue of realizing it’s just a lot harder to design specific things than initially thought without a deep working knowledge of computer-aided software (CAD) design.
Most people know how to throw a football, but that doesn’t mean that most people can be Super Bowl quarterback Tom Brady.
The high-quality 3D printing designs were reserved for authentic professionals that could put together complicated designs.
The move to compiling a comprehensive library will help spur on the 3D printing revolution while upping the foundational skill base.
Then there is the fact that 3D printing technology is heaps better now than it once was, and the printing technology has come down in price making it more affordable for the masses.
These trends will propel broad-based adoption and as the printing process standardizes, more products can rely on this technology from scratch.
The holy grail of 3D printing would be 3D printing on demand, but imagine this on-demand 3D printing would function to personalize a physical product on the spot.
Think of a hungry customer walking into a restaurant and not even looking at a menu because one sentence would be enough to trigger specific models in the database that could conjure up the design for the meal.
This would involve integrating artificial intelligence into 3D printing and the production process would quicken to minutes, even seconds.
At some point, crafting the perfect meal or designing a personalized Tuscan villa could take minutes.
The 3D printing industry is reaching an inflection point where the advancement of the technology, expertise, and an updated production process are percolating together at the perfect time.
The company at the forefront of this phenomenon is Stratasys (SSYS).
Stratasys produces in-office prototypes and direct digital manufacturing systems for automotive, aerospace, industrial, recreational, electronic, medical and consumer products.
And when I talk about real pros who have the intellectual property to whip out a complex CAD-based 3D design, I am specifically talking about Stratasys who have been in this business since the industry was in its infancy.
And if you add in the integration of cloud software, 3D printing would dovetail nicely with it.
All the elements are in perfect in place to fuel this industry into the mainstream.
Take for example airplanes made by Boeing (BA) and Airbus - 3D printer-designed parts comprise only 0.1% of the actual plane now.
It is estimated that 3D printed design parts could potentially consist up to 25% of the overall plane.
These massive airline manufacturers like Boeing (BA) have profit margins of around 15% to 20%, and carving out more 3D printer-designed parts to integrate into the main design will boost profit margins close to 60%.
The development of the 3D printing process into aerospace technology is happening fast with Boeing inking a multi-year collaboration agreement with Swiss technology and engineering group Oerlikon to develop standard processes and materials for metal 3D printing.
Any combat pilot knows who Oerlikon is because they are famed for building ultra-highspeed machines to shoot down, you guessed it, airplanes and missiles.
They will collaborate to use the data resulting from their agreement to support the creation of a standard titanium 3D printing processes.
GE’s Aviation’s GEnx-2B aircraft engine for the Boeing 747-8 is applying a 3D printed bracket approved by the Federal Aviation Administration (FAA) for the engine, replacing a traditionally manufactured power door opening system (PDOS) bracket.
With the positive revelations that the (FAA) is supporting the adoption of 3D printing-based designs, GE has already started mass production of the 3D printed brackets at its Auburn, Alabama facility.
Defense companies are also dipping their toe into the water with aerospace company Lockheed Martin (LMT), the world’s largest defense contractor, winning a $5.8 million contract with the Office of Naval Research to help further develop 3D printing for the aerospace industry.
They will partner up to investigate the use of artificial intelligence in training robots to independently oversee the 3D printing of complex aerospace components.
3D printed designs have the potential to crash the cost of making big-ticket items from cars to nuclear plants while substantially shortening the manufacturing process.
As it stands, Stratasys is the industry leader in this field and if you believe in this long term then this stock would be for you.
It’s nonetheless still a speculative punt but a compelling pocket of the tech industry.
“Capitalism has worked very well. Anyone who wants to move to North Korea is welcome.” – Said Founder and Former CEO of Microsoft Bill Gates
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to a six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three-day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more
Global Market Comments
October 15, 2019
Fiat Lux
Featured Trade:
(HOW TO HANDLE THE FRIDAY, OCTOBER 18 OPTIONS EXPIRATION),
(ONLY TEN MORE DAYS UNTIL THE MAD HEDGE LAKE TAHOE, NEVADA CONFERENCE, OCTOBER 25-26, 2019)
Followers of the Global Trading Dispatch have the good fortune to own THREE deep in-the-money options position that expires on Friday, October 18, and I just want to explain to the newbies how to best maximize their profits.
These involves the:
the Russell 2000 (IWM) October 2019 $137-$142 in-the-money vertical Bull call spread at $5.00
the Russell 2000 (IWM) October 2019 $153-$156 in-the-money vertical BEAR PUT spread at $3.00
the United States Oil Fund (USO) October 2019 $9.50-$10.00 in-the-money vertical Bull call spread at $0.50
The total profit on all three positions will increase the value of our $100,000 model trading portfolio by an impressive 4.55%, or $4,550. These positions only became possible due to the extreme volatility (VIX) seen in the market in October, thanks to trade war fears, euphoria, then feat again.
Given that all of these positions are 5% in-the-money or more, we have enough of a cushion to run these into the Friday option expiration.
Provided that we don’t have a monster “RISK OFF” move in the market this week (more failure of the China trade talks? War with Iran? A massacre in Hong Kong?) which causes stocks to collapse and volatility to rocket, these positions should expire at its maximum profit points. So far, so good.
I’ll do the math for you on the first Russell 2000 position. Your profit can be calculated as follows:
Profit: $5.00 - $4.45 = $0.55
(22 contracts X 100 shares per option X $0.55 net profit)
= $1,210 or 12.46% in 13 trading days.
Many of you have already emailed me asking what to do with these winning positions.
The answer is very simple. You take your left hand, grab your right wrist, pull it behind your neck, and pat yourself on the back for a job well done.
You don’t have to do anything.
Your broker (are they still called that?) will automatically use your long position to cover your short position, canceling out the total holdings.
The entire profit will be credited to your account on Monday morning October 21 and the margin freed up.
Some firms charge you a modest $10 or $15 fee for performing this service.
If you don’t see the cash show up in your account on Monday, get on the blower immediately and find it.
Although the expiration process is now supposed to be fully automated, occasionally mistakes do occur. Better to sort out any confusion before losses ensue.
If you want to wimp out and close the position before the expiration, it may be expensive to do so. You can probably unload them pennies below their maximum expiration value.
Keep in mind that the liquidity in the options market disappears, and the spreads substantially widen, when a security has only hours, or minutes until expiration on Friday. So, if you plan to exit, do so well before the final expiration at the Friday market close.
This is known in the trade as the “expiration risk.”
One way or the other, I’m sure you’ll do OK, as long as I am looking over your shoulder, as I will be, always. Think of me as your trading guardian angel.
I am going to hang back and wait for good entry points before jumping back in. It’s all about keeping that “Buy low, Sell high” thing going.
I’m looking to cherry-pick my new positions going into the next quarter-end.
Take your winnings and go out and buy yourself a well-earned dinner. Or use it to put a down payment on a long cruise.
Well done, and on to the next trade.
Here’s to Another Trade Well Done!
Mad Hedge Biotech & Healthcare Letter
October 15, 2019
Fiat Lux
Featured Trade:
(CASHING IN ON ECONOMIES OF SCALE WITH CIGNA)
(CI), (ESRX), (AET)
The future of health care will be no doubt driven by massive economies of scale that crush costs and balloon profit margins and there has been no better practitioner of that philosophy than Cigna Corp. (CI)
The company recently reported a robust quarterly blowout. The managed care service provider disclosed that it recorded $4.30 in earnings per share for the second quarter, crushing the Wall Street estimate of $3.74 per share. Total profits were recorded to be $34.4 billion, also topping previous estimates of $33.2 billion.
Among the revenue components of Cigna, pharmacy sales were identified as major pushers as it reached $26.3 billion -- a huge jump from the $750 million recorded during the same period in 2018. This is primarily due to the acquisition of pharmacy benefit manager Express Scripts for $67 billion in December last year. Cigna’s premiums also went up 8.9% year-over-year to reach $9.8 billion. Meanwhile, fees grew 76% to $2.39 billion.
The move to merge with Express Scripts (ESRX) has allowed Cigna to secure long-term growth as the company transformed into a one-stop-shop for clients’ healthcare needs. It can now cater to demands ranging from drug sales up to insurance coverage. Since it brings together both medical services and pharmacy benefits under one roof, Cigna has become a more attractive option for its ability to provide better treatments and lower expenses.
With this deal, Cigna gained a competitive position to become one of the major movers in the healthcare insurance industry. So far, the combined company is projected to generate a minimum free cash flow of $6 billion by 2021.
However, one major obstacle in Cigna’s growth is the uncertainty arising from the current political climate in the United States ahead of the 2020 election. Cigna’s share price almost perfectly inversely tracks with the polling numbers of Elisabeth Warren, who has essentially promised to nationalize the company. The better she does the worse Cigna does, and that has given us our entry point.
At the moment, health insurers remain uncertain of some aspects of their business due to potential regulatory changes that could plunge them into debt.
To address this, Cigna is following the footsteps of fellow healthcare giants like Aetna Inc (AET) which sold its group life and disability unit to Hartford Financial Services Group for $1.45 billion in 2017.
While Cigna hopes that the merger with Express Scripts could help mitigate the effects of future government policy changes, the company is still actively seeking other alternatives.
One of its plans is to sell its group benefits insurance unit, which has an estimated value of $6 billion, to other insurers with an already established division and are looking to scale. The sale could include the life and accidental death as well as dismemberment coverage clusters of Cigna. This move will allow the company to focus more on healthcare.
Given its revenue trajectory in the first half of 2019 though, the company’s outlook indicates a continuing momentum into year-end. In fact, Cigna’s total revenues this year are projected to rise somewhere between $136 and $137 billion compared to the $132.5 and $134.5 billion range predicted earlier. This indicates a 180% increase year-over-year.
Meanwhile, its earnings per share are expected to reach $16.90 compared to the earlier earnings guidance of $16.65, representing a 17% rise year-over-year. The company’s medical clients are estimated to increase by roughly 200,000 as well, achieving 97% to 98% customer retention in its health services sector in 2020.
Cigna’s expansion to establish an international presence is also a promising move towards diversification. In the first quarter of 2019, the company acquired OnePath Life Insurance from the ANZ Bank in New Zealand. This deal allows Cigna to gain access to an existing client base and offer an expanded set of services.
Aside from achieving international operations expansion, this acquisition also reassures Cigna’s investors of the company’s capacity to effectively deploy capital to drive long-term growth.
So far, Cigna has provided strong reasons for it to be a “BUY.” In terms of its growth rate, the company’s revenues showed a CAGR of 11% from the year 2010 up to 2018. However, it rose by 194% in the first half of this year, courtesy of its Express Scripts merger. Its recent acquisitions also demonstrated consistent top-line growth and the ability to effectively distribute its products and services.
Apart from its top-line growth, Cigna has also managed to maintain its bottom-line profitability. This is clear in the annual earnings growth it recorded since 2009 and its efforts to maintain operating profitability via controlled medical care and other operating costs.
While the Diary of a Mad Hedge Fund Trader focuses on investment over a one week to the six-month time frame, Mad Day Trader, provided by Bill Davis, will exploit money-making opportunities over a brief ten minute to three-day window. It is ideally suited for day traders, but can also be used by long-term investors to improve market timing for entry and exit points. Read more