Tuesday, June 11, 2013

Markets Soft without Stimulus

Markets around the world pulled back the reigns as central banks look to taper quantitative easing. Japan’s central bank decided to leave their current pace of monetary policy unchecked, which has effectively cut the Nikkei down 1.5% on the day, affecting nearly every market in-between, scaring the DJIA 165 points off the start this morning. US Treasuries have now notched the highest yield in 14 months on the 10 year note.

This morning 55,257 EEM July 35 puts were purchased by a trader for $0.29 each, costing him a large $1,602,453. This is a bearish move on the Emerging Markets ETF, with expectations that by the July expiration, the price of EEM will dip below $34.71. EEM opened today at $39.32 and if this trader was to pass the breakeven point, the ETF would have to drop by more than 11.7% within a little over a month.

EEM opened today 1.9% lower than its closing price yesterday and since the 52-week high the ETF experienced in early January, it has lowered by over 13%. While this may sound like 11% is not too big of an estimate for the bearish trend that EEM has been experiencing, the drop between early January and now took place over a much longer time period than between now and when the July puts expire. EEM also showed a slight rally from mid-April until early May, but fell short of the January high by about 2.3% and has declined ever since.

Another way to analyze the stock technically is to compare the moving averages. Four days ago from today the 200-day moving average crossed above the 50-day moving average. This is known as a death cross; when the long-term moving average pushes above the short-term moving average this hints at a future bearish trend. EEM has already shown bearish behavior, and this could mean that the decline could continue further. Looking at historical data, last summer the 50-day moving average dipped below the 200-day moving average, and EEM reached its 52-week low a month after.

Attention to the actual health of the emerging country relative to others is another tool. When looking at currencies in these countries such as the Thai Baht, South African Rand, and Brazil Real, there is a noticeable depreciative trend when compared to the USD. For the past month and a half, the value of the dollar has appreciated steadily against the Baht (by 7.8%), the Rand (by 13.7%), and the Real (6.7%). This is indicative that the economies of these emerging markets are not doing as well as the United States, and therefore money might begin to flow from them and back into the US.

The US economic policies hold water over emerging markets as well. Expectations in the news recently have been stipulating when the Fed would begin tapering the quantitative easing and therefore decrease bond prices as raise bond yields rise. This would cause risk-averse investors to put their money into US bonds in order to capitalize off of the higher yield and lower risk that these bonds would provide over emerging market investments, thereby drawing money out of these markets and bringing money into the United States.

Monday, June 10, 2013

Monsanto’s stock makes way while sun shines

Monsanto surges nearly 5% after announcing that the seed making conglomerate will effectively extend and increase its stock buyback after its current repurchase campaign finalizes on July 1. This new program will increase to purchase $2 billion worth of company stock over the next three years. This news from the agriculture behemoth comes as Standard & Poor’s raised its credit rating to “stable” from “negative.”

MON earns its keep from three main sources of generating revenue: agricultural chemical sales, designing and selling biotechnology traits, and collecting royalties on the aforementioned traits. When estimating expected returns, Monsanto management analyzes historical returns, economic trends, market conditions and changes in consumer demand.

Corn seeds make up for three quarters of Monsanto’s seed sales; the USDA projected 2013 production to top 2012 by 32%. This is good news for MON; the more seeds, the merrier-- corn seed has been on a 16% tear. Herbicides to cater the strains of GMO grains are one of three major tributaries of revenue. Corn seed demand domestically and in South America, along with China warming up to import GMOs have lead analysts at Macquire to upgrade the stock to “outperform.” Despite the visible demand, Monsanto’s products are a thin spread above generics. A trader in the market seem to agree.

This morning, 2,500 Monsanto Oct 95 puts were purchased at $2.48 and paired with a sale of 2,500 Oct 80 puts for $0.62. The purchase of these puts indicates an option to sell over $23 million shares of Monsanto, while the sale of the puts indicates a commitment to purchase $20 million shares of Monsanto.

This strategy to combine the purchase of puts along with the sale of puts at a different strike price is a way to both limit risk and limit reward; the limited reward has a larger range of profitability as compared to a normal purchase of a put. The trader might not be so sure where the price of Monsanto will be in October, however they do believe that the price of Monsanto will ease over the next couple of months – the breakeven point of this trade is at a price of $93.14 per share, with profits below this price and losses above. The maximum loss the trader can incur is $465,000 if the price of the stock is above $95 at the October expiration. On the other hand, the maximum reward the trader can gain from this trade is $3,285,000 if the price of the stock is below $80.

Today the stock opened at $105, and therefore between now and October the trader will make their maximum profit if the stock drops by 23.8%. In order to be in the black, the price would have to drop by 11.3%. 

This expectation by the trader seems pretty drastic, and this could possibly be a hedging strategy that the trader has used to protect their long position in the company. For instance, if the trader was going to be profitable above $95/share, then they would only take a slight dip in reward (-465,000). However if the trader was going to lose a lot of money below $80/share, this could be comfortably offset by a gain of over three million dollars.

Friday, June 7, 2013

Stocks Stumble Only to Stand Back Up

Week in review June 3-7 2013

S&P 0.7%

Dow 0.83%

Russel 2000 0.34%

GLD -0.65%

TLT(Barclays 20 year us treasury index) -0.94%

VIX -7.31%

“Far more money has been lost by investors preparing for corrections or trying to anticipate corrections than has been lost in the corrections themselves” (Peter Lynch) 

June started off ominous as we saw a continuation of the largest selloff the market has seen in 2013.    On Thursday’s low (1598 in the S&P 500) the marked had slumped a total of 5.27% from the year-to-date high (1687), and the CBOE volatility Index VIX had climbed to 18.51. Technical analysts look for the S&P500 to be at a relative low while the VIX is at a high.  This coupled with an increase in volume signals that there is a culmination in the selling.  When the S&P fell below the 50 day moving average of 1606 the selling pressure peaked and when the dust settled, the SPX closed at 1643 for the week.  This rally got wind in its sail from the lukewarm American job report this morning, giving American investor’s confidence that the economy is on stable ground, and that the Fed tapering may not be as soon as some thought.

The market slump first began in the US with a hint of Fed tapering, which has caused significant volatility in the bond market.  The Fed comments eventually caused equities to fall, giving us a taste of what could potentially happen when the fed does actually start its tapering.  If the market is this volatile when the fed suggests it could tapper, what will happen once it actually does?  And what will happen if they decide to unwind?   Traders of volatility are certainly expecting a rocky third quarter.  To take advantage of that possibility a popular trade this week was to use this short term spike in volatility to take profits on their current hedges, and roll them out into the fall.  We still view that the larger risk in the US market is in treasuries, but, as we have seen, volatility has a way of spilling over in the short term to equities.  This morning former Fed Chairman Alan Greenspan attempted to calm nervousness in the equities markets by stating "The most important positive force in the economy at the moment is the fact that equity premiums are so high, which means the downside on stock prices is quite limited," he said. "If we can get stock prices to rise, which they will if this thing stabilizes, then you get a lot of asset-growth effect on the economy."  Suggesting that downside risk in equities is limited due to the high yields they are paying while at the same time warned of a potential black swan bond event if the fed does not unwind their assets correctly.

The market was also heavily impacted this week by the tremendous volatility coming out of Japan.  The Nikkei was 20% off its highs in 11 days…and six of those days were up!   This is a cautionary sign of what can happen when there is an abrupt change in fiscal policy.  The carry trade, (sell yen, buy higher yielding assets) had become more crowded than rush hour traffic.  Japanese markets had been on a tremendous tear all year long.  The Fed Japanese bank was printing money at a tremendous rate, and many people were scratching their heads sitting on the sideling thinking this is too easy, I need to get long the Nikkei.  That mentality helped the Nikkei rise 40% from November.  However what goes up fast can sometimes go down fast when it corrects.  As soon as there was a hint of negative economic data everybody wanted out at the same exit.  People thought the fiscal policies pronounced by ABE would not be enough to pull Japan out of deflation.  Simply put, the Nikkei had gone to fast too soon.  The stock market had grown ahead of the economy on speculation.  However in America there is a saying, “don’t fight the fed”.  In Japan, with their powerful fixed income market, that saying should hold true.  If the BOJ is committed to create inflation, it will eventually create it.  Therefore we were buyers of the Nikkei this week on weakness.

What we are watching for next week June 10-14

June option expiration is two weeks away.  If prices are stable options will start to decay more rapidly as the week progresses.  The first three days of the week is light on economic data.  Typically on light economic data days we see the market continue its current trend.  We will be watching to see if Japan will continue to rally off the good economic data out of the US on Monday. 

How are we positioned to profit from that?

We continue to hold our long equities portfolios.  We are not going to fight the Fed or the BOJ.  They continue to ease and we will not jump too far ahead of them.  Traders should consider the lesson learned from the Japan carry trade, you don’t need to swing for the fences, remain long but hedged.  This week we took advantage in the pop in market volatility by selling out some of our volatility hedges.   And for some strategies we were able to get short volatility at which will be profitable if the VIX remains below 16.   We maintain our core strategy to balance long stock positions with a tradable volatility hedge.

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Thursday, June 6, 2013

Yahoo Bears Search for a Correction

There has been recent activity with Yahoo put options today, where a large quantity of June 25 puts were bought for thirty and thirty-five cents. These were done in quantities of 300-500 contracts, giving the traders the right to sell tens of thousands of YHOO shares. This is a bearish bet that Yahoo stock price will drop below $24.65, which these traders expect to happen by expiration on June 13. For this to occur YHOO would need to drop 4.8% over the next 15 days.

Yahoo offers personalized technology services for their clients, connecting users with the exact content they need. In turn, Yahoo sells that information to advertisers and marketers. Yahoo’s CFO Ken Goldman’s opinion expressed confidence in the Sunnyvale, California company. At a recent conference he remarked, “We’re not afraid to make any decisions” when prompted on Yahoo’s taste for acquisitions. Goldman has an eye on the mobile market, and cites the acquisitions “to help basically accelerate our progress … and continue to see the velocity of products in the mobile space.” Yahoo recently bought Tumblr for $1.1 billion, and has a non-binding bid for Hulu along with a slew of other bidders.

However, despite the leadership’s confidence, the $25 puts may pay off. Yahoo is due to release second quarter earnings on July 23, 2013 with estimates at $0.30. This is $0.08 lower than Yahoo’s first quarter results.

Since last fall, Yahoo has shown a bullish trend. Between early January and mid May, Yahoo has experienced 6 different peaks that were followed by a short downtrend before continuing to rise. The fastest and largest decline occurred in mid April and lasted for 4 days. The longest decline lasted 16 days in early March, and the average length of a downturn was about 9 days. In mid May, Yahoo stock reached a peak at $27.68 and has been in a downward trend ever since. This has lasted for 22 days so far, and today could be very pivotal. The bull trend lines suggest that Yahoo had broke below the support 14 days ago, and it appears that it is now acting as a resistance.

The next few days are very important when analyzing the position of Yahoo. If the stock rallies now, it would be a short term correction inside of a larger bullish trend. However, if the price begins to drop, then the old support price levels can now act as a resistance and there will be a drop in Yahoo prices, providing a profit for the traders that bought puts.

Wednesday, June 5, 2013

US Treasury Sale Stalls GM's Rally

A large trade of over 3200 June 13 calls was sold shortly after the U.S. Treasury Department released a statement that it will sell 30 million share of the Detroit automaker General Motors. The United Auto Workers will also sell an additional 20 million shares of the Motor City staple, slowing any potential rally on the stock with a total of 50 million shares now on the market. 

Since there are suddenly 50 million new and shares hitting the market, they are expecting the stock to perhaps stay stagnant or slightly increase but certainly not exceed the strike of $36. They will collect the premium from selling the call if the stock stays below $36, , but for that buffer, the seller loses the right to capture any market rally above $36.

Today the Treasury Department gave notice that it will empty its 300 million dollar position in the company by early next year. This has resulted in the slight slump GM is experiencing today (-1.5%). This is because since the treasury has committed to selling stock, traders will be able to wait a while and purchase them at a lower price as a supplier tries to unload inventory. After the treasury has dumped its positions the stock should climb back up as investor expectation in the company is more positive – the company has been showing growth since its crisis and has generally been rallying from lows last summer. 

All seems to be going well for GM, the government is showing confidence in the market by taking its hand out of Detroit’s pockets. The Treasury sale announcement came shortly after GM’s sales rose 9.4% in China. GM sold just fewer than 3 million units in China last year, beating out Toyota and Volkswagen. This Meanwhile in the States, GM will maintain its title as number one car manufacturer from the S&P 500 Index. This index welcoming should complement the sale well, as funds and firms that follow the Standard & Poor’s will need to purchase GM in order to maintain a balanced portfolio.

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