Mad Hedge Technology Letter
February 12, 2018
Fiat Lux
Featured Trade:
(DON'T FALL INTO THE SNAP TRAP),
(SNAP), (FB), (GOOGL), (AMZN)
It is often said that the best performance of a share price is triggered when the fundamentals go from awful to merely terrible.
That has certainly been the case for long suffering SNAP (SNAP), which delivered one of the best performing stocks in an otherwise disastrous market last week, up an amazing 37%.
You can thank this ballistic move due to a surprise report delivering earnings of 12 cents a share, the first ever for the company. The company added 9 million daily users, taking their total to 187 million. The number of adds place rose by 400%.
So much for the silver lining. Now for the cloud.
SNAP is a minnow attempting to swim in an ocean filled with sharks and whales, like Alphabet (GOOGL), and Amazon (AMZN).
Ad prices fell by 70%. SNAP is expected to continue to lose money through 2021. What's worse, Facebook (FB) is about to eat their lunch, appetizer, entree, and dessert in all.
SNAP was one of the preeminent IPO disasters of 2017. It launched in March at $17 and then soared 44% on the first day to $29. It then collapsed to a low of $11.40, off a heartbreaking 60.68%. It was a classic case of investment banker incompetence, greed, and mispricing.
Snapchat, wildly popular with adolescents and young adults, is a social networking platform that took off when it debuted on NYSE in March 2017.
Based on photos and videos clips the user can "snap" and send to other users, only to disappear after viewing, this innovation allowed the young people of the world access to the ultimate social media dream: a quick and convenient way of documenting every waking moment of their lives (generally through the smartphone app).
Sadly, the exuberance was short lived.
Snapchat was the most accurate description of a technology laggard in 2017.
Imitation is the sincerest form of flattery and understanding the machinations at a technical level with give us more color.
The addition of a new feature, giving users the option of adding snaps to their "story", a chronological account of their day vanishing in 24 hours, seemingly caught the attention of other big players who were taking careful tabs on this progress.
Facebook (FB) seamlessly cloned the same core features responsible for Snapchat's (or Snap Inc.) rise to fame.
Modern-day tech is made up of unique networks that are often difficult to build; once built and scaled efficiently, however, the reach cannot be replicated.
Gaining eyeballs is what feeds Snap's success. As Facebook and it's daughter companies systematically mimic its best features, user preference to stay within the familiar Facebook ecosystem, rather than venturing into the unknown, has become more evident.
Facebook's Instagram will continue to position itself accordingly as competitors in the tech space start to cannibalize each other for user attention. This is definitely not a "rising tide lifts all boats" scenario. There are winners and losers in this game, and Snap's direct rivalry with Instagram doesn't make its prospects look good.
2018 marks a key year for Facebook; protecting the core user experience will be vital for harvesting user trust in the arena. This natural evolution has forced Facebook CEO Mark Zuckerberg to prioritize personal networks over brute commerce.
We can expect a short term hit to ad load, but an offset by improved quality user experience in the long term. Spinning off new ideas, fluid integration, and brisk execution illustrates the ability of Facebook management teams to adapt and reload.
Granted, Snapchat had a late start, a factor partly responsible for their showing up to a shootout with a butter knife. All the same, the daunting Instagram challenge seems grim because the digital ad duopoly is hard to disrupt and if their DAU growth is already this unimpressive then watch out below!
Tech titans plow a substantial portion of their cash back into developing their user experience, which is critical to engaging active users, stabilizing ad pricing, and increasing ad load. In short, it's an arduous task for Snap to compete with Instagram's unlimited resources.
M&A has taken hold in the tech world, with the behemoths identifying companies that would exhibit synergies fitting into their ecosystems; cash is certainly not a problem.
Examples are rampant: Amazon's purchase of Whole Foods, Facebook's purchase of Oculus Rift, etc. In cases where Goliath doesn't buy David out, he crushes him under relentless competition.
This means that even if Snap improves its user experience, Facebook can mobilize its developers to replicate these functions almost instantaneously, throttling any hope of making a comeback by moving in a different direction.
Snapchat is in the midst of rolling out a major redesign of its platform to commercialize their product, but does it matter? Facebook will simply take the best parts of the new redesign and integrate it into Instagram as free innovation.
Nor does it help that many companies felt it unnecessary to buy ads on Snap when Facebook and Instagram have more user engagement follow through and over 2 billion active daily users.
That's the game today: have the technology to imitate competitors and trap users inside an ecosystem; hyper-improve the experience, and any and every click of the mouse benefits the bottom line through data analytics, ads, and sales.
As the tech space has matured, the juggernauts have realized that speed and agility will help them offer a better user experience, regardless of where the innovation comes from.
Inevitably, Facebook ad pricing will rise due to less inventory, and this short squeeze will drive growth in earnings. Facebook ad offerings are, in effect, an auction and the price can be bid up. Any company that cannot afford Facebook's rates can logically migrate to Instagram where the pricing is a level lower and geared to a younger audience with lower spending power.
Simple supply and demand will exacerbate competition for these ads like the San Jose housing market. At the same time, it's unsurprising that the Snap revenue estimates have been guided lower and lower and actually there is no guidance for Q1 2018 while Facebook's revenue accelerates. This is not coincidence. Don't forget that a stock is worthy of your undivided attention if it sequentially beats earnings and raises revenue consistently like Nvidia (NVDA).
Snap catastrophically fails at the two most important metrics for tech growth companies: daily active user growth and accelerated revenue growth. Q4 2017 was a transition quarter but the odds are asymmetrically stacked against them.
The torrid equity strength in the first month of the year failed to include Snap, while interest rate-sensitive stocks and large tech stocks skyrocketed. Moreover, Snap's daily active user growth has flattened like a pancake to 2.9% in Q3 2017 and Q4 showed anemic increases allowing the Mad Hedge Fund Trader to paint Snap as transitional at best.
With marginal stocks typically being victim to the steepest and swiftest declines, expect that if the market rolls over and consolidates further, Snap may likely be bludgeoned into nonexistence.
For Facebook, on the other hand, the only downside is they may need to start coming up with their own innovations.
Avoid SNAP. If you own SNAP get rid of it, and thank the heavens it spiked on earnings which gave traders a perfect exit point for Snap. After the broad market correction has run its course, Snap will not be the torchbearer of the next gap up. If you are looking for a Snap like replacement in your portfolio then Twitter (TWTR) would fit like a glove.
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
When John identifies a strategic exit point, he will send you an alert with specific trade information as to what security to sell, when to sell it, and at what price. Most often, it will be to TAKE PROFITS, but, on rare occasions, it will be to exercise a STOP LOSS at a predetermined price to adhere to strict risk management discipline. Read more
Global Market Comments
February 9, 2018
Fiat Lux
Featured Trade:
(FEBRUARY 14 GLOBAL STRATEGY WEBINAR),
(SHORT SELLING SCHOOL 101),
(SH), (SDS), (PSQ), (DOG), (RWM), (SPXU), (AAPL),
(VIX), (VXX), (IPO), (MTUM), (SPHB), (HDGE)
Mad Hedge Technology Letter
February 9, 2018
Fiat Lux
Featured Trade:
(HANGING OUT WITH THE WOZ),
(AAPL)
With the stock market falling for the next few weeks, or even months, it's time to rehash how to profit from falling markets one more time.
There is nothing worse than closing the barn door after the horses have bolted.
No doubt, you will receive a wealth of short selling and hedging ideas from your other research sources and the media at the next market bottom. That is always how it seems to play out.
So I am going to get you out ahead of the curve, putting you through a refresher course on how to best trade falling markets now.
Market's could be down 10% by the time this is all over.
THAT IS MY LINE IN THE SAND!
There is nothing worse than fumbling around in the dark looking for the matches after a storm has knocked the power out.
I'm not saying that you should sell short the market right here. But there will come a time when you will need to do so. Watch my Trade Alerts for the best market timing. So here are the best ways to profit from declining stock prices, broken down by security type:
Bear ETFs
Of course the granddaddy of them all is the ProShares Short S&P 500 Fund (SH), a non leveraged bear ETF that is supposed to match the fall in the S&P 500 point for point on the downside. Hence, a 10% decline in the (SPY) is supposed to generate a 10% gain the in the (SH).
In actual practice, it doesn't work out like that. The ETF has to pay management operating fees and expenses, which can be substantial. After all, nobody works for free.
There is also the "cost of carry," whereby owners have to pay the price for borrowing and selling short shares. They are also liable for paying the quarterly dividends for the shares they have borrowed, around 2% a year. And then you have to pay the commissions and spread for buying the ETF.
Still individuals can protect themselves from downside exposure in their core portfolios through buying the (SH) against it (click here for the prospectus). Short selling is not cheap. But it's better than watching your gains of the last seven years go up in smoke.
Virtually all equity indexes now have bear ETF's. Some of the favorites include the (PSQ), a short Play on the NASDAQ (click here for the prospectus), and the (DOG), which profits from a plunging Dow Average (click here for the prospectus).
My favorite is the (RWM) a short play on the Russell 2000, which falls 1.5X faster than the big cap indexes in bear markets (click here for the prospectus).
Leveraged Bear ETFs
My favorite is the ProShares Ultra Short S&P 500 (SDS), a 2X leveraged ETF (click here for the prospectus). A 10% decline in the (SPY) generates a 20% profit, maybe.
Keep in mind that by shorting double the market, you are liable for double the cost of shorting, which can total 5% a year or more. This shows up over time in the tracking error against the underlying index. Therefore, you should date, not marry, this ETF or you might be disappointed.
3X Leveraged Bear ETFs
The 3X bear ETFs, like the UltraPro Short S&P 500 (SPXU), are to be avoided like the plague (click here for the prospectus).
First, you have to be pretty good to cover the 8% cost of carry embedded in this fund. They also reset the amount of index they are short at the end of each day, creating an enormous tracking error.
Eventually, they all go to zero, and have to be periodically redenominated to keep from doing so. Dealing spreads can be very wide, further added to costs.
Yes, I know the charts can be tempting. Leave these for the professional hedge fund intra day traders they are meant for.
Buying Put Options
For a small amount of capital, you can buy a ton of downside protection. For example, the April (SPY) $182 puts I bought for $4,872 allowed me to sell short $145,600 worth of large cap stocks at $182 (8 X 100 X $6.09).
Go for distant maturities out several months to minimize time decay and damp down daily price volatility. Your market timing better be good with these, because when the market goes against you, put options can go poof, and disappear pretty quickly.
That's why you read this newsletter.
Selling Call Options
One of the lowest risk ways to coin it in a market heading south is to engage in "buy writes." This involves selling short call options against stock you already own, but may not want to sell for tax or other reasons.
If the market goes sideways, or falls, and the options expire worthless, then the average cost of your shares is effectively lowered. If the shares rise substantially they get called away, but at a higher price, so you make more money. Then you just buy them back on the next dip. It is a win-win-win.
I'll give you a concrete example. Let's say you own 100 shares of Apple (AAPL), which closed on Friday at $95.13, worth $9,513. If you sell short 1 July, 2016 $100 call at $1.30 against them, you take in $130 in premium income ($1.30 X 100 because one call option contract is exercisable into 100 shares).
If Apple closes below $100 on the July 15, 2016 expiration date, the options expire worthless and you keep your stock and the premium. You are then free to repeat the strategy for the following month. If (AAPL) closes anywhere above $100 and your shares get called away, you still make money on the trade.
Selling Futures
This is what the pros do, as futures contracts trade on countless exchanges around the world for every conceivable stock index or commodity. It is easy to hedge out all of the risk for an entire portfolio of shares by simply selling short futures contracts for a stock index.
For example, let's say you have a portfolio of predominantly large cap stocks worth $100,000. If you sell short 1 June, 2016 contract for the S&P 500 against it, you will eliminate most of the potential losses for your portfolio in a falling market.
The margin requirement for one contract is only $5,000. However if you are short the futures and the market rises, then you have a big problem, and the losses can prove ruinous.
But most individuals are not set up to trade futures. The educational, financial, and disclosure requirements are beyond mom and pop investing for their retirement fund.
Most 401ks and IRAs don't permit the inclusion of futures contracts. Only 25% of the readers of this letter trade the futures market. Regulators do whatever they can to keep the uninitiated and untrained away from this instrument.
That said, get the futures markets right, and it is the quickest way to make a fortune, if your market direction is correct.
Buying Volatility
Volatility (VIX) is a mathematical construct derived from how much the S&P 500 moves over the next 30 days. You can gain exposure to it through buying the iPath S&P 500 VIX Short Term Futures ETN (VXX), or buying call and put options on the (VIX) itself.
If markets fall, volatility rises, and if markets rise, then volatility falls. You can therefore protect a stock portfolio from losses through buying the (VIX).
I have written endlessly about the (VIX) and its implications over the years. For my latest in-depth piece with all the bells and whistles, please read Buy Flood Insurance With the (VXX)by clicking here.
Selling Short IPO's
Another way to make money in a down market is to sell short recent initial public offerings. These tend to go down much faster than the main market. That's because many are held by hot hands, known as "flippers", and don't have a broad institutional shareholder base.
Many of the recent ones don't make money and are based on an, as yet, unproven business model. These are the ones that take the biggest hits.
Individual IPO stocks can be tough to follow to sell short. But one ETF has done the heavy lifting for you. This is the Renaissance IPO ETF (click here for the prospectus).
Buying Momentum
This is another mathematical creation based on the number of rising days over falling days. Rising markets bring increasing momentum, while falling markets produce falling momentum.
So selling short momentum produces additional protection during the early stages of a bear market. Blackrock has issued a tailor made ETF to capture just this kind of move through its iShares MSCI Momentum Factor ETF (MTUM). To learn more, please read the prospectus by clicking here.
Buying Beta
Beta, or the magnitude of share price movements, also declines in down markets. So selling short beta provides yet another form of indirect insurance. The PowerShares S&P 500 High Beta Portfolio ETF (SPHB) is another niche product that captures this relationship.
The Index is compiled, maintained and calculated by Standard & Poor's and consists of the 100 stocks from the (SPX) with the highest sensitivity to market movements, or beta, over the past 12 months.
The Fund and the Index are rebalanced and reconstituted quarterly in February, May, August and November. To learn more, read the prospectus by clicking here.
Buying Bearish Hedge Funds
Another subsector that does well in plunging markets are publicly listed bearish hedge funds. There are a couple of these that are publicly listed and have already started to move.
One is the Advisor Shares Active Bear ETF (HDGE) (click here for the prospectus). Keep in mind that this is an actively managed fund, not an index or mathematical relationship, so the volatility could be large.
Oops, Forgot to Hedge
"Every recession sows the seeds for the next business recovery, and every recovery sows the seeds of the next recession." said hedge fund manager Leon Cooperman of Omega Advisors.