Posts

Shopping for Fire Insurance During a Hurricane

With the Volatility Index back at a lowly $12, I am getting deluged with emails from readers asking if it is time to start hedging portfolios one more time and buying the iPath S&P 500 VIX Short Term Futures ETN (VXX).

The answer is no yet, but soon, possibly very soon.

They are inquiring at absolutely the right time.

And here is the problem. When the (VIX) rises, it usually spikes straight up, and then right back down again. That means the stock market has one more sharp selloff left before we hit bottom for 2020 and bounce.

Markets can ignore trade wars, rising interest rates, zero interest rates, foreign assassinations, falling earnings, and international political instability (Britain and Hong Kong) for a while, but not forever. When the time DOES come to pay the piper, prices with volatility will rocket.

So I am more than usually interested in hedging the downside risk for my trading book. A good rule of thumb is to let the (VIX) sit at a bottom for weeks, and then go buy the (VXX). That way you can ignore expensive and unnecessary time decay.

Which all brings me to the subject at hand.

If you are new to the service and have no longs, you probably should skip this trade and just watch it as a learning experience.

This can also be a great hedge for any long positions we may want to add in the coming weeks, such as in “trade peace,” or technology plays.

As I never tire of telling people, no one ever complains when they buy fire insurance and their house doesn’t burn down.

If you are new to this service, don’t freak out. My daily research newsletters are not always about exploring the esoterica of options, or volatility trading.

I’ll let you know when I’m ready to pull the trigger with a Trade Alert.

I am always trying to get better prices.

If you are new to the (VIX) game, please read the educational piece below.

 

 

 

January 10, 2020

Global Market Comments
January 10, 2020
Fiat Lux

Featured Trade:

(FRIDAY, FEBRUARY 7 PERTH, AUSTRALIA STRATEGY LUNCHEON)
(JANUARY 8 BIWEEKLY STRATEGY WEBINAR Q&A),
(VIX), (VXX), (TSLA), (SIL), (SLV),
 (WPM), (RTN), (NOC), (LMT), (BA), (EEM)

December 20, 2019

Global Market Comments
December 20, 2019
Fiat Lux

Featured Trade:

(DECEMBER 18 BIWEEKLY STRATEGY WEBINAR Q&A),
(BA), (CRSP), (BABA), (GLD), (PANW), (VIX), (VXX)

September 5, 2019

Global Market Comments
September 5, 2019
Fiat Lux

SPECIAL VOLATILITY ISSUE

Featured Trade:

(SHOPPING FOR FIRE INSURANCE IN A HURRICANE),
(VIX), (VXX), (XIV),
(THE ABCs OF THE VIX),
(VIX), (VXX), (SVXY),

The ABCs of the VIX

I am one of those cheapskates who buy Christmas ornaments by the bucketload from Costco in January for ten cents on the dollar because my 11-month theoretical return on capital comes close to 1,000%. 

I also like buying flood insurance in the middle of the summer drought when the forecast in California is for endless days of sunshine. That is what we had at the end of July when the (VIX) was plumbing the depths of $12.

Get this one right, and the profits you can realize are spectacular.

It gets better. 

If the bottom in volatility exactly coincides with the peak in the stock market that it measures, volatility could be headed back up to the 30% handle, and maybe more. 

I double dare you to look at the charts below and tell me this isn’t happening.

Watch carefully for other confirming trends to affirm this trade is unfolding. Those would include a strong dollar, and a weak Japanese yen, Euro, and rising fixed income instruments of any kind.

Notice that every one of these is happening this week!

Reversion to the mean, anyone?

You may know of this from the many clueless talking heads, beginners, and newbies who call (VIX) the “Fear Index”. 

For those of you who have a Ph.D. in higher mathematics from MIT, the (VIX) is simply a weighted blend of prices for a range of option contracts on the S&P 500 index (SPX).

The formula uses a kernel-smoothed estimator that takes as inputs the current market prices for all out-of-the-money calls and puts for the front-month and second-month expirations. 

The (VIX) is the square root of the par variance swap rate for a 30-day term initiated today. To get into the pricing of the individual options, please go look up your handy dandy and ever-useful Black-Scholes equation. 

You will recall that this is the equation that derives from the Brownian motion of heat transference in metals. Got all that?

For the rest of you who do not possess a Ph.D. in higher mathematics from MIT, and maybe scored a 450 on your math SAT test, or who don’t know what an SAT test is, this is what you need to know. 

When the market goes up, the (VIX) goes down. When the market goes down, the (VIX) goes up. Period. End of story. Class dismissed.

The (VIX) is expressed in terms of the annualized monthly movement in the S&P 500 (SPX) which, with the (VIX) today at $10, is at $72.54. 

So for example, a (VIX) of $10 means that the market expects the index to move 2.89%, or $72.54 S&P 500 points, over the next 30 days. 

You get this by calculating $10/3.46 = 2.89%, where the square root of 12 months is 3.46. 

The volatility index doesn’t really care which way the stock index moves. If the S&P 500 moves more than the projected 2.89% in ANY direction, you make a profit on your long (VIX) positions. 

I am going into this detail because I always get a million questions whenever I raise this subject with volatility-deprived investors.

It gets better. 

Futures contracts began trading on the (VIX) in 2004 and options on the futures since 2006. 

Since then, these instruments have provided a vital means through which hedge funds control risk in their portfolios, thus providing the “hedge” in hedge fund.

 

August 19, 2019

Global Market Comments
August 19, 2019
Fiat Lux

Featured Trade:

(MARKET OUTLOOK FOR THE WEEK AHEAD, or WHAT A ROLLER COASTER RIDE!),
(SPY), (TLT), (VIX), (VXX), (M),
(WMT), (FB), (AMZN), (GOOGL), (IWM)

The Market Outlook for the Week Ahead, or What a Roller Coaster Ride!

I like roller coasters. The Giant Dipper at the Santa Cruz Boardwalk is tough to beat, the last operating wooden coaster in the United States. And I’ll always have fond memories of the Cyclone at Coney Island in New York.

I especially liked this week in the financial markets, which provided more profitable trading opportunities, both on the long and the short side, that any other week of the past decade.

Perhaps the highpoint was on Thursday when I was staring at my screens watching ten year US Treasury bond yields (TLT) bottom at a near historic 1.46%, and my own Mad Hedge Market Timing Index plunging to a lowly 19.

Impulsively, I covered the last of my short positions and started piling on longs in the FANGs. The next morning, the Dow Average opened up 300 points. But then, it’s easy to be bold and decisive when you’re up 30% on the year, compared to only 11% for the Dow Average.

And guess what? The best may be yet to come!

As long as the Volatility Index stays over $20, you will be able to print all the money you want with options spreads. I’m talking 10%-15% A MONTH!

All eyes are now on September 1 when the Chinese announce their own retaliation to our tariff increase. Will they target ag again? Or does the bond market (TLT) take the hit this time (the Chinese government owns $900 billion worth of our debt).

And now for the question that everyone is asking: How far will the stock market fall in this cycle. We have already plunged 10% from the highs on an intraday basis. Could we drop another 10% in this period of high anxiety? Certainly. However, I tend to think it will be less than that.

The initial market pop on Monday came when the new Chinese tariffs were delayed, from September 1 to December 15, on some items. Tell me who saw this one coming. The potential costs of the tariffs are hitting the US more than China. It was worth a 550-point rally in the Dow Average. In 50 years, I’ve never seen such blatant market manipulation.

Gold hit a new six-year high, with the collapse of the Argentine Peso a new factor. A poor election result drove the beleaguered currency down 15% in one day, a massive move.

Now you have to worry about what’s happening in China AND Argentina. For the first time in history, gold now has a positive yield versus the Europe and the Japanese Yen, which both offer negative interest rates.

Hong Kong is becoming a factor driving US markets down. If there is a repeat if the 1989 Tiananmen Square massacre where thousands died, global markets could collapse. The hit to growth will be more than it currently can stand in its present weakened state.

Inflation is taking off, with Core Consumer Inflation for July coming in at a red hot 0.3%, delivering the strongest two-month price burst since 2006. If it keeps up, you can kiss those future interest rate cuts goodbye.

Germany is in recession. That is the only conclusion possible when you see Q2 at -0.1% growth and the economy still in free fall. The ZEW’s figures regarding Germany yesterday were nothing short of horrific as the Economic Sentiment Index fell to -44. When you damage China’s economy, it puts the rest of the world into recession. The global economy has become so interlinked, it can’t become undone without another great recession.

Bonds rates bottomed yesterday, at least for the short term, the intraday low for the ten-year US Treasury yield hitting 1.46%. Welcome to inversion land, where long term interest rates are below short-term ones. Confidence in the economy is melting like an Alaskan glacier. But with three more 25 basis point rate cuts to come, an eventual break below 1.0% is inevitable. Watch for stocks to remake half their recent losses.

Consumer Sentiment cratered in August from 97.0 estimated to 92.1. And that was before the stock market sold off. Consumer spending remains strong. The last time it was this strong was at the market top in 2008, the market top in 1999, and the market top in 1987.

July Housing Starts plunged 4.0%, to 1.191 million units as homebuilders move into recession mode. Not even record low-interest rates can get them to stick their necks out this time. Those that did last time got wiped out.

It’s been pedal to the metal all month with the Mad Hedge Trade Alert Service, with no less than 31 Trade Alerts going out so far. Some 18 or the last 19 round trips have been profitable, generating one of the biggest performance jumps in our 12-year history.

Since July 12, we have clocked a blistering 15.15% in profits or $15,150 for the model $100,000 trading portfolio.

My Global Trading Dispatch has hit a new all-time high of 330.65% and my year-to-date shot up to +30.51%. My ten-year average annualized profit bobbed up to +34.20%. 

I have coined a blockbuster 12.18% so far in August. All of you people who just subscribed in June and July are looking like geniuses. My staff and I have been working to the point of exhaustion, but it’s worth it if I can print these kinds of numbers.

The coming week will be a snore on the data front. Believe it or not, it could be quiet.

On Monday, August 19, nothing of note is released.

On Tuesday, August 20 at 10:30 AM, we get API Crude Oil Stocks.

On Wednesday, August 21, at 10:00 the Existing Home Sales are published for July.

On Thursday, August 22 at 8:30 AM, the Weekly Jobless Claims are printed. The Jackson Hole conference of global central bankers and economists begins.

On Friday, August 23 at 8:30 AM the July New Home Sales are announced.

The Baker Hughes Rig Count follows at 2:00 PM.

As for me, I will be attending the Pebble Beach Concourse d’Elegance vintage car show where I will be exhibiting my 1925 Rolls Royce Phantom I, the best car ever made.

I don’t mind the wooden brakes, but it’s too bad they didn’t make adjustable seats in those days to fit my 6’4” frame. However, its price appreciation has been better than Apple’s (AAPL) which I bought as a fixer upper in England during the 1980s for $20,000. My average cost on Apple is a split adjusted 25 cents.

My Rolls will be shown alongside James Bond’s 1964 Aston Martin which sold for $6.3 million, a 1939 Volkswagen Type 64 priced at more than $20 million, and a $13 million 1958 Ferrari 250 GT BBT.

And what am I doing next weekend? Taking the Boy Scouts to the Six Flags roller coaster farm in Vallejo.

Good luck and good trading.

John Thomas
CEO & Publisher
The Diary of a Mad Hedge Fund Trader

 

 

 

 

 

 

 

My Phantom I

 

1939 Volkswagen

 

1954 Ferrari

August 9, 2019

Global Market Comments
August 9, 2019
Fiat Lux

Featured Trade:

(AUGUST 7 BIWEEKLY STRATEGY WEBINAR Q&A),
(SPY), (XLK), (GLD), (DIS), (TLT),
 (FXA), (FXY), (VIX), (VXX), (UNG), (USO)

August 7 Biweekly Strategy Webinar Q&A

Below please find subscribers’ Q&A for the Mad Hedge Fund Trader August 7 Global Strategy Webinar with my guest and co-host Bill Davis of the Mad Day Trader. Keep those questions coming!

Q: Are we headed for a worldwide depression with today’s crash and interest rates?

A: No, I think the interest rates are more of an anomaly unique to the bond market. There is a global cash glut all around the world and all that money is pouring into bonds—not for any kind of return, but as a parking place to avoid the next recession. The economic data is actually stronger than usual for pre-recession indicators. US interest rates going to zero is just a matter of coming in line with the rest of the world. Three to six months from now we may get our final bear market and recession indicators.

Q: Do you think the market has more downside?

A: Yes; if the 200-day moving average for the (SPY) doesn’t hold, then you’re really looking at a potential 20% correction, not the 8% correction we have seen so far.

Q: Which sector would you focus on for any dips?

A: Technology (XLK). If they lead the downturn, they’re going to lead the upturn too. It’s the only place where you have consistent earnings growth going out many years. You’re really all looking for an opportunity to go back into Tech, but the answer is a firm not yet.

Q: Would you buy gold (GLD), even up here?

A: Only if you can take some pain. We’re way overdue for a correction on essentially everything—stocks, bonds, gold, commodities—and when we get it, you can get a real snapback on all these prices. The time to enter gold trade was really a month ago before we took off, and I’ve been bullish on gold all year. So, I think you kind of missed the entry point for gold just like you missed the entry point for shorts on the stock market last week. You only want to be selling decent rallies now. You don’t want to be selling into a hole that makes the risk/reward no good.

Q: What can you say about the (FXA) (the Australian dollar)?

A: It’s holding up surprisingly well given the carnage seen in the rest of the financial markets. I want to stand aside until we get some stability, at which point I think (FXA) will pop up back to the $71 level. New Zealand cutting their rates by 50 basis points really came out of the blue and could eventually feed into a weaker Aussie.

Q: Do you think China (FXI) has no reason to make a trade deal until the US elections?

A: Absolutely not; and this puts a spotlight on the administration’s total inexperience in dealing with China. I could have told you on day one: there’s no way they’re going to settle. Pride is a major factor in China. They have long memories of the opium wars and all the abuses they received at the hands of the western powers and are highly sensitive to any kind of foreign abuse. If you want to get the opposite of a settlement, do exactly what Trump is doing. The administration’s policy has no chance of accomplishing anything. He’s willing to take a lot more pain in the stock market until he gets a deal and that’s bad for all of us.

Q: How does the extra 10% tariff affect the market?

A: Think of everything you’re buying for Christmas; the price goes up 10%. That’s the effect, and it completely wipes out any earnings the retail industry might have had. It’s only bad. We are suffering less harm than China in the trade war, but we are suffering, nonetheless.

Q: Do you think volatility will spike soon?

A: It may very well have already spiked. I don’t think we’ll get a spike as high as in past selloffs because there’s a big short volatility industry that has come back. Any moves more than $30, you have short sellers come in there very quickly to hammer things back down. Also (VIX) isn’t necessarily something you want to be buying after the stock market has already dropped 8%. That train has left the station.

Q: Would a weaker dollar benefit the US economy?

A: Yes; it makes our exports cheaper on the global market. However, if the rest of the world is weakening their currencies as well, it will have no effect. Also, the last time this kind of currency war was attempted was in the early 1930s, and the outcome was the Great Depression.

Q: Defensive stocks—the China story is getting uglier?

A: In this kind of market, I’ve never been a big fan of defensive stocks like utilities or healthcare because defensive stocks go down in bear markets, just at a slower rate than growth stocks because they never went up in the first place. The best defensive stock is cash.

Q: If US interest rates are going to zero, how about buying leaps on (TLT)?

A: Multi-year highs is just not leap buying territory. Multiyear lows are where you buy LEAPS, which are Long Term Equity Participation Certificates. They are basically long-dated 1-2-year call options on stocks that are rising over the long term. The better trade—when we get to zero interest rates and it becomes impossible for rates to go any lower—would be to do a reverse leap. If (TLT) goes up to $200, I would do something like a $150-$160 on the put side betting that sometime over the next 2 years, interest rates go back up again and bonds go down. Too late for LEAPS on bonds, too early for LEAPS on equities.

Q: Do you buy out of the money LEAPS?

A: Yes; that is where you get the triple-digit returns. For example, you can buy the Walt Disney (DIS) June 2021 $150-$160 vertical bull call spread today for $3.30. If we close over $160 by then the spread will be worth $10, up 203% from your cost. And you only need a rise of 25% from here to get that return. This is why I love LEAPS, but only at medium term market bottoms.

Q: Is crude oil (USO) going to $25 on a barrel global slowdown fears?

A: I think you need an actual recession to go down to $25; in the current environment, $42 is a nice target. The basic problem is global structural oversupply and falling demand, which is a classically unfortunate combination for prices. 

Q: When will interest rates go to zero?

A: Sooner than later, I would say. My original guess was sometime next year but at the rate we’re going, we could be there by the end of the year.

Q: Would you get involved in natural gas (UNG)?

A: Absolutely not; this is the high season for natural gas right now when summer air conditioner use creates peak demand. It certainly has been hot this summer, especially on a global basis, and if you can’t rally natural gas in this environment you never will. There is also a huge contango in (UNG) which most people can’t beat.

 

 

 

 

July 26, 2019

Global Market Comments
July 26, 2019
Fiat Lux

Featured Trade:

(JULY 24 BIWEEKLY STRATEGY WEBINAR Q&A),
(FCX), (VIX), (VXX), (UUP), (TLT), (EEM), (ELD), (CEW), (GLD),
(FXA), (FXE), (FXC), (FXY), (FXB), (AMZN),
(TESTING TESLA’S SELF DRIVING TECHNOLOGY),
(TSLA)