Our goal is to generate 10% returns every month, consistently, using iron condors. If you're tired of whipsaws and drawdowns in your trading account, see what our options strategies can do to help you generate a solid monthly income.
If you’re not already in a pretty delta-neutral place, think about balancing things out tomorrow ahead of the 2:15 fireworks. We closed out one of our newsletter positions today for a small loss so that we can ride through the rest of May expiration with less risk and little concern about the magnitude of any market reactions.
We won’t do the reversal readings tonight, suffice to say that (with the exception of the QQQQs) the indexes have worked off their previous short-term overbought conditions, relieving the pressure by way of time rather than price. Still, if you have a bullish perspective there remain some points of concern. VIX and More has some great material on possible market complacency here, while the Ticker Sense folks remark that when the indexes and so many major sectors are sitting right at or above the tops of their trading envelopes, it might pay to be cautious.
This week should be pretty volatile, with plenty of government data, earnings announcements, and Fed action to push markets to and fro. Many traders are paying special attention to the GDP announcement Wednesday morning and the FOMC news later that afternoon. As is our wont, we advise taking off some risk ahead of Fed meetings.
Markets were very quiet until the last forty-five minutes today, trading on very light volume, and the S&P 500 emini futures weren’t able to break above the 1404 level. Some higher volume selling pushed the Dow and the SPX into negative territory into the close.
Citigroup must have updated the methodology for their panic/euphoria model, as cited regularly in Barron’s. We know this because - as you can see from the chart at left - even at the absolute peak of exuberance back in October 2007, the model gave an official reading of “0″, meaning sentiment was neither euphoric nor panicked. Those of us who were alive and trading during those halcyon days might remember things somewhat differently.
In any case, that same panic/euphoria model registered a reading above 0.3 over the weekend, which must be the highest on record, and only makes sense if you assume that some new methodology has been put in place. We’ll reset our expectations about this metric, and see whether it provides any useful indications going forward.
Speaking of Citigroup: David Gaffen at the WSJ MarketBeat blog has a good piece on why the rally in banking stocks may have overextended itself.
By the first half of 2006, before the Federal Reserve had even stopped raising interest rates, economists were beginning to recognize where things could very well be headed: monetary policy easing, forced by a slowing economy and tightening credit, would both put downward pressure on the dollar (which already had resumed its decline by the end of 2005) and cause yields on U.S. Treasury bonds to plummet. The inflation risk was obvious to any educated consumer watching the news, but what some economists and analysts were also starting to consider was the possibility of a U.S. dollar end-game - foreign governments and institutions unwinding their dollar investments. The majority of experts dismissed the idea, arguing that investors couldn’t shun the dollar, because they’d be shooting themselves in the foot by causing their huge dollar-denominated holdings to lose even more value.
Fast-forward to this week. Despite sporadic reports that China was cutting back investment of its foreign reserves in U.S. Treasuries and other dollar-denominated assets, the media had pretty much lost interest in the story and was keeping its myopic focus on the housing crisis, the credit crunch, and the Bear Stearns failure. Then on Wednesday, an article in the Financial Times confirmed that migration of foreign funds out of the dollar is real and spreading.
The Times reported that South Korea’s National Pension Service - the fifth largest pension fund in the world - “will no longer buy U.S. Treasuries because yields are too low.” The story quotes an NPS spokesperson:
“It is difficult to buy more US Treasuries because the portion of our Treasury investment is already too big and Treasury yields have fallen a lot,” said Kwag Dae-hwan, head of global investments at the NPS. “We need to diversify our portfolio away from US Treasuries and we find asset-backed securities and corporate debt more attractive because of wider credit spreads.”
This is a very big fund, but surely one institution in one country does not a trend make. True. But the very next day, another Financial Times story revealed that Chinese exporters are moving away from the dollar:
According to Alibaba.com, the online company that matches Chinese suppliers with international buyers, the vast majority of their almost 700,000 Chinese suppliers no longer use dollars to settle non-US transactions to minimise foreign exchange risk.
“They are moving to euros, pounds, Australian dollars or even quoting prices in renminbi,” David Wei, chief executive, told the Financial Times. Moreover, he added, prices quoted in dollars were now often valid for just seven days compared with the 30-60 days common previously.
And there also was this item from Bloomberg earlier in the week:
Asian Central Banks Look to Invest Reserves in Region
By Arijit Ghosh and Aloysius Unditu
March 24 (Bloomberg) — Central banks from 16 Asian nations may invest more of their $1 trillion of foreign reserves in the region’s debt as Federal Reserve interest-rate cuts reduce returns on U.S. assets.
“This is something that most of us, that are not yet investing in, will be looking at,” Bangko Sentral ng Pilipinas Governor Amando Tetangco said in a March 23 interview in Jakarta. There can be “some kind of shift” to Asian sovereign bonds, Central Bank of Sri Lanka Governor Ajith Nivard Cabraal said in a separate interview on March 22, after a weekend meeting of policy makers from the region.
What happens if this trend continues? A sell-off in U.S. Treasuries would cause market interest rates to rise, despite whatever the Federal Funds target rate may be. Rising interest rates would make it tough for the economy to start growing again. At that point, all those assurances we were given that the recession would be “short and shallow” would fly out the window.
A couple people vehemently disagreed with our post suggesting a cautious entry into gold this week. Maybe they’re right: maybe the commodity boom is over, maybe the housing troubles and liquidity problems are a thing of the past, and maybe the Fed is going to start getting tough on inflation at the next meeting and will start raising rates. And maybe Mount St Mary’s will beat UNC tonight and go all the way to the finals. But at least a few others also see a chance to start small in gold here. [Mark Hulbert, Peter McGuire]
Roger Ehrenberg at Information Arbitrage is skeptical of all those cheering the Fed:
I mean, a snap-back in the wake of hundreds of billions of Fed intervention was not particularly surprising, no? But read some headlines today and it is as if the Fed and Bernanke have won. Won what? A three-day reprieve from a long-term problem that is necessarily exacerbated by the Fed’s historic injection of liquidity to avert crisis? I mean come on. Can’t we even wait a few months before knighting Sir Ben and anointing him “Slayer of the Evil Commodities Bubble?”
Andy Swan of Mytrade (which includes us in their options section - awesome!) has started posting about the iron condors he’s trading, calling it a “Be the House” strategy. This is exactly right: the two best metaphors for trading iron condors have always been the casino and the insurance company. But the reason we really appreciate Andy’s post is that he takes the small-and-steady approach to position management:
And…this position is just getting started….I’ll end up with 8-10x this position by expiration day. 2-3 times per week I will add to the position by putting on a new vertical spread on the high or low side (depending on which way the markets are moving that day), slowly moving closer and closer to the live price of SPY over the next 3 weeks. For example, today I might sell options that are $7 or $8 out of the money, but next week I’ll be selling options $5 or $6 out, all the way up to expiration week where I will likely be putting on trades that are merely a buck or two out of the money.
After the big market swing in January, several people started asking why we don’t use hard stops in our trades. The answer is that iron condors already have hard stops built in, since they’re defined-risk positions. Andy gets this point right, too:
Despite ALL of that insanity, this position was profitable by being market neutral and taking advantage of premium-decay of the out-of-the-money options that we sold.
On the other hand, huge numbers of traders saw all of their directional positions STOPPED OUT FOR LOSSES during the violent swings up and down. That’s the problem with stops….they hit.
Instead, we sell premium and establish positions with a DEFINED RISK and therefore need NO STOP whatsoever. We can sleep at night because we know that the worst case scenario is already defined and acceptable to us!
In other words, you should ask whether you’re comfortable with the worst case scenario for any given trade. If you’re not, then that’s a crystal-clear signal that you’re over-allocating capital, and should consider diversifying across more trades, more strike prices, multiple months, multiple underlyings, etc. etc.
Filed Under (Bonus Trades, Fed) by CondorTrader on 19-03-2008
Two directional trades we’re looking at today that are both consistent with the story that this week’s positive action is just a brief pause in a longer bear market.
Gold
Thesis: Gold has been almost unbuyable for months as it kept hitting new highs - if you weren’t in already, it was pretty tough to get in so late in the game. This week may be your opportunity, as the Fed decision caused the biggest single-day plunge in gold since June 2006:
Gold futures for April delivery fell $58.30, or 5.8 percent, to $946 an ounce at 12:49 p.m. on the Comex division of the New York Mercantile Exchange. A close at that price would mark the biggest percentage drop for a most-active contract since June 13, 2006. The metal climbed in the previous six sessions, gaining 3.3 percent.
[...] “There is some measurable support for gold in the low $900s,” Hanlon said. “There isn’t heavy support until $800. It may sound like a dramatic decline, but it’s a correction in a bull market.” Before today, gold climbed 20 percent in 2008 after gaining for seven straight years. [Bloomberg]
We’re seeing pretty strong follow-through on yesterday’s decline, so this looks like a nice opportunity for a contrarian play.
Trade: GLD, the ETF loved by so many, hasn’t listed options yet, so we have to get a little more creative to make this play. Two mining companies stand out:
Barrick Gold (ABX) has pretty great volume in both the options and the stock, so we like the short 40/35 April put vertical for a $0.50 credit (selling the April 40 puts and buying the April 35 puts), or if you’re not into credit spreads, the April 50 calls are currently about $1.30.
Compania de Minas Buenaventura (BVN) is another way to play this sector. The liquidity in these options isn’t as strong as in ABX, so you would want to trade small, but the stock has behaved better of late and tracks GLD more closely than does ABX. A nice credit spread here would be the short 65/60 April put vertical for $1.20 (short the 65 puts, long the 60 puts), or you could buy the April 80 calls for $2.00. BVN traded above $85/share as recently as last week.
A word of caution: the volume in these names has been strong, and there’s no guarantee that gold will bounce back promptly, especially since so many investors may have profits to take out first. So it’s worth the trouble to ease into any positions here, and you may need to be prepared to roll these positions forward if the reversal takes longer than expected.
Fannie Mae
Thesis: This story is even simpler: federal regulators provided $200bn to the mortgage-backed securities market by easing capital requirements on Fannie Mae and Freddie Mac.
Regulators for the two companies cut their surplus capital requirement to 20 percent from 30 percent to help expand their combined $1.5 trillion in mortgage investments and revive the home-loan market. The change is expected to provide $200 billion in funds to the mortgage-backed securities market, the Office of Federal Housing Enterprise Oversight said in a news release. [Bloomberg]
The thesis here is just that eased restrictions don’t mean Fannie Mae is out of the woods. Effectively, regulators are just allowing them to increase their leverage, and injecting more capital into the mortgage market won’t help FNM if foreclosures continue to pile up. This seems like just another cash infusion by short-sighted regulators who are more interested in immediate stability than they are in long-term financial solvency.
Trade: The implied volatility in the April options has spiked up to 114% (historically, the IV in FNM options is usually closer to 60), so you’ll have to pay if you just want long puts: the FNM April 29 puts are about $2.25. Alternatively, you could sell the April 35/40 call spread for $1.05 (short the 35 calls, long the 40 calls).
As always, these bonus trades are provided purely for educational and entertainment purposes; though if you find random options trades entertaining, you should probably get out more.
