Tagged: Options Expirations

Three Days

Some energy-sector clients lost 40% of market-capitalization in three days last October.

A year and a half cultivating share-appreciation and by Wednesday it’s gone.  How so?  To get there let’s take a trip.

I love driving the Llano Estacado, in Spanish “palisaded steppe” or the Staked Plains. From Boise City, OK and unfolding southward to Big Spring, TX lies an expanse fit for nomads, an unending escarpment of mottled browns and khakis flat as iron rail stretching symmetric from the horizon like a sea.

Spanish explorer Francisco Coronado wrote, “I reached some plains so vast that I did not find their limit anywhere I went.” Here Comanches were dominating horse warlords for hundreds of years. Later sprouted first the oil boom early last century around Amarillo and again in the 21st century a neoclassical renaissance punctuated by hydraulic fracturing in the Permian Basin.

The air sometimes is suffused with mercaptan, an additive redolent of rotten egg that signals the otherwise invisible presence of natural gas. But the pressure of a relentless regimen silts away on a foreshortened compass, time seeming to cease and with it the pounding of pulses and devices.  It’s refreshing somehow.

And on a map one can plot with precision a passage from Masterson to Lampasas off The Llano and know what conquering that route demands from clock and fuel gauge.

Energy stocks in August 2014 were humming along at highway speed and then shot off The Llano in October, disappearing into the haze.

(Side note: If you want to discuss this idea, we’re at the NIRI Tristate Chapter in Cincinnati Wed Mar 18 and I’m happy to entertain it!)

What happened?  There are fundamental influences on supply and demand, sure. But something else sets prices. I’ll illustrate with an example. Short interest is often measured in days-to-cover meaning shares borrowed and sold and not yet bought and returned are compared to average daily trading volume. So if you move a million shares daily and your short interest is eight million, days-to-cover is eight, which may be good or bad versus your average.

Twice in recent weeks we’ve seen big blocks in stocks, and short volumes then plunged by half in a day. Both stocks declined. Understand, short interest and short volume differ. The former is shares borrowed but not yet covered. It’s a limited measure of risk.  Carry a big portfolio at a brokerage with marginable accounts and you can appropriate half more against it under rules.

Using a proxy we developed, marketwide in the past five days short volume was about 44%, which at 6.7 billion total shares means borrowed shares were 2.95 billion. Statistically, nearly 30% of all stocks had short volume above 50%.  More shares were rented than owned in those on a given day. (more…)

Market Facts

Volatility derivatives expire today as the Federal Reserve gives monetary guidance. How would you like to be in those shoes? Oh but if you’ve chosen investor-relations as your profession, you’re in them.

Management wants to know why holders are selling when oil – or pick your reason – has no bearing on your shares. Institutional money managers are wary about risking clients’ money in turbulently sliding markets, which condition will subside when institutional investors risk clients’ money. This fulcrum is an inescapable IR fact.

We warned clients Nov 3 that markets had statistically topped and a retreat likely would follow between one and 30 days out. Stocks closed yesterday well off early-Nov levels and the S&P 500 is down 100 points from post-Thanksgiving all-time highs.

The point isn’t being right but how money behaves today. Take oil. The energy boom in the USA has fostered jobs and opportunity, contributing to some capacity in the American economy to separate from sluggish counterparts in Asia and Europe. Yet with oil prices imploding on a sharply higher dollar (bucks price oil, not vice versa), a boon for consumers at the pump becomes a bust for capital investment, and the latter is a key driver in parts of the US that have led job-creation.

Back to the Fed, the US central bank by both its own admission and data compiled at the Mortgage Bankers Association (see this MBA white paper if you’re interested) has consumed most new mortgages coming on the market in recent years, buying them from Fannie Mae and Freddie Mac and primary dealers.

Why? Consumption drives US Gross Domestic Product (GDP), and vital to recovery in still-anemic discretionary spending is stronger home prices, which boost personal balance sheets, instilling confidence and fueling borrowing and spending.

Imagine the consternation behind the big stone walls on Maiden Lane in New York. The Fed has now stopped minting money to buy mortgages (it’ll churn some of the $1.7 trillion of mortgage-backed securities it owns, and hold some). With global asset markets of all kinds in turmoil, especially stocks and commodities, other investors may be reluctant successors to Fed demand. Should mortgages and home-values falter in step with stocks, mortgage rates could spike.

What a conundrum. If the Fed fails to offer 2015 guidance on interest rates and mortgage costs jump, markets will conclude the Fed has lost control. Yet if a fearful Fed meets snowballing pressure on equities and commodities by prolonging low rates, real estate could stall, collapsing the very market supporting better discretionary spending.

Now look around the globe at crashing equity prices, soaring bonds, imploding commodities, vast currency volatility (all of it reminiscent of latter 2008), and guess what?  Derivatives expire Dec 17-19, concluding with quad-witching. Derivatives notional-value in the hundreds of trillions outstrips all else, and nervous counterparties and their twitchy investors will be hoping to find footing.

If you’ve ever seen the movie Princess Bride (not our first Market Structure Map nod to it), what you’re reading seems like a game of wits with a Sicilian – which is on par with the futility of a land war in Asia. Yet, all these things matter to you there in the IR chair, because you must know your audience.  It’s comprised of investors with responsibility to safeguard clients’ assets. (more…)

Perspective

It’s not what you think.  Heard that phrase before?

Last Wednesday, Oct 15, apparently everybody trading equities believed the world was dissolving in an apocalyptic stew of Ebola, European recession, unused petroleum, Chinese debt and Mideast terror. The DJIA at one point dropped 460 points.

Son of a gun. By Friday, October 17 we were back to milk and honey and Captain Crunch! The DJIA rose 263 points. Human nature is fickle. But this juxtaposition stretches credulity. It’s also a lesson on market structure.

In 2013, according to the Investment Company Institute, net US inflows to mutual funds were $152 billion, of which $52 billion went to target-date hybrid funds (mixes of bonds and equities based on one’s age), and about $53 billion to index funds, 82% of which track major market measures like the S&P 500. Exchange-traded funds garnered another $180 billion, mostly equity instruments that track funds tied to indices.

If two-thirds of the net new cash followed asset-allocation vehicles and a greater sum still sought ETFs, which post daily market positions, the likelihood that most of your price-movement reflects fundamentals is low unless you have an activist (event-driven money can catalyze bipolarity in market behavior – higher highs and lower lows).

There’s an animation sequence I’ve seen that starts with what appears to be mountains or desert from great height. Then our vantage point pans back and we see with surprise that it’s something else entirely: the brown pupil of a person’s eye.  We sweep back and the person is standing on a shoreline. Then back we scan across forests, mountains, rivers, countries and then continents until we’re in space seeing below us a lovely cobalt sphere, and we pan further, and it’s the blue pupil of a giant being. (more…)

Risk

We figured if The President goes there it must be nice.

Reality often dashes great expectations but not so with Martha’s Vineyard where we marked our wedding anniversary. From Aquinnah’s white cliffs to windy Katama Beach, through Oak Bluffs (on bikes) to the shingled elegance of Edgartown, the island off Cape Cod is a winsome retreat.

Speaking of retreat, my dad, a Korean Police Action era (the US Congress last declared war in 1943, on Romania. Seriously.) veteran, told me his military commanders never used the word retreat, choosing instead “advance to the rear!”

Is the stock market poised for an advance to the rear? Gains yesterday notwithstanding, our measures of market sentiment reflected in the ten-point ModernIR Behavioral Index dipped to negative this week for the first time since mid-August. Risk is a chrysalis formed in shadows, studied by some with interest but generally underappreciated.

It happened in 2006 in housing, when trader John Paulson recognized it and put on his famous and very big short. Most missed the chrysalis hanging rather elegantly in the mushrooming rafters of the hot residential sector.

It happened in the 17th century Dutch tulip bubble, an archetype for manic markets.  Yet then tulips and buyers didn’t suddenly explode but just the money behind both, as ships from the New World laden with silver and gold flooded Flanders mints with material for coin. Inflation is always and everywhere a monetary phenomenon.

It’s hard to say if mania is here hanging pupa-esque on the cornices of the capital markets. Most say no though wariness abounds. Mergers are brisk and venture capital has again propagated a Silicon Valley awash in money-losing firms with eye-popping values. Corporate buybacks will surpass $1 trillion in total for 2013-2014, capital raking out shares from markets like leaves falling from turning September trees. (more…)

The Risk

On a hot Sunday 138 years ago today, Lieutenant Colonel George Armstrong Custer rode into the valley Native Americans called the Greasy Grass. The rest is history.

Speaking of unexpected defeat, wonder what ambush caused yesterday’s sharp market reversal? Here’s a ModernIR Rule: The day after a new marketwide series of options and futures begins trading is a leading indicator of institutional asset-allocation plans.

Options and futures expired June 18-20. The new series took effect June 23. Yesterday was Rule Day.  Counterparties including major broker-dealers hold inventory through expirations and these resets. If stocks then decline, they had too much inventory for demand-levels.

Now, one can blame bearish Dubai stocks or sudden weakness in the UK Sterling or something else. But this rule is consistently true: If there’s more money in equities, stocks rise because counterparties undershot estimates. The reverse? Counterparties dump inventory and stocks drop.

Is this dip the tip of the long-anticipated bear turn?  Right now, total sentiment by our measures doesn’t show that risk. But. Sentiment has consistently faded before offering investors a market-top for profit-taking, in itself a bearish signal.

Speaking of risk, Cliff Asness’s high-speed trading piece at Bloomberg is humorous and compelling. I admire the AQR founder for his smarts, success and libertarian leanings.

But I disagree on HFT.  Mr. Asness defends it, saying: “The current competitive market-based solution is delivering the product, meaning liquidity for investors, better and cheaper than ever. Moving away from this competitive landscape would be an invitation for incompetent central planning or rapacious monopolistic practices.” (more…)

Fires, Crashes and Kill Switches

Suppose the engine of your vehicle was on fire.

The logical response would be to shut it off. But what if you were traveling at highway speed and killing the fuel supply meant you had no power breaks or steering? What if your vehicle was a jet fighter?

There are ramifications.

Last Thursday and Friday stocks plunged. Monday and Tuesday this week, shares soared. I doubt most of us think that people were selling in a stampede last week and then woke up Monday and went, “Shazzam! What have we done? We should be buying!”

Context matters.

This week offers an event in similar rarified air as blood moons in the northern hemisphere. Good Friday closes markets to end the week. Between are the usual three sets of expirations: volatility derivatives, index futures, and the remaining host of options and futures set for monthly expiry (with earnings now too – another reminder for you learned IROs to avoid that mash-up if at all possible). (more…)

The Flood

The word of the week was “flood.”

Here in Colorado, Denver had a coup d’état by weather patterns from Portland, Oregon for a week but our streets never ran in torrents. Where the Rocky Mountain watershed empties to the flood plain from the Mesozoic Era, occupied by present-day Boulder, Loveland and Greeley and small towns like Evans and Lyons hugging the banks of normally docile tributaries, the week past reshaped history and landscape. It will take months to recover.

In the markets too there was and remains a flood that surfaces with rising intensity from its subterranean aquifers to toss debris into market machinery. It’s the spreading vastness of complex market data.

SIDEBAR: If you’re in St. Louis Friday, join us at the NIRI luncheon Sept 20 for a rollicking session on the equity market – how it works and why it fails at times.

Data is the fuel powering market activity. Globally, trading in multiple asset classes turns on computerized models that depend on uninterrupted streams of reliable data. This gargantuan global data cross-pollination affects trading in your shares. After all, there are two million global indexes, as the WSJ’s Jason Zweig noted in a poignant view last weekend on modern equities. (more…)

A Movable Feast

Bonjour! Ca va?

We’re back from touring Provence aboard cycling saddles, weighing heavier on the pedals after warmly embracing regional food and drink. Lavender air, stone-walled villages perched over vineyards, crisp mornings and warm days, endless twilight, chilled Viogniers from small-lot Luberon wineries. If these things appeal, go.

In Avignon we feasted at Moutardier in the shadow of the Palais du Papes, the palace of the Roman Catholic popes in the 14th century. From tiny hilltop Oppede-le-Vieux with roots to earliest AD written in moldering stone and worn cobble we surveyed the region’s agricultural riches. After a long climb up, we saw why Gordes is where the rich and famous from Paris and Monte Carlo go to relax. And on Day 5 I scratched off the master life list riding fabled Mont Ventoux, which will host the Tour de France on Bastille Day, July 14. What a trip.

Meanwhile back at the equity-market ranch, things got wobbly. We warned before departing that options-expirations June 19-21 held high risk because markets had consumed arbitrage upside and new swaps rules would make the process of re-risking unusually testy. Markets tumbled.

The Fed? Sure, Ben Bernanke’s comments unnerved markets. But if we could see it in the data before the downdraft occurred, then there’s something else besides the reactions of traders and investors at work. (more…)

Swapping the Future

Whole swaths of stocks moved 3% yesterday. You might thank Dodd-Frank for it, even if David Tepper gets credit (if you heard the Appaloosa Management founder’s interview you know what I mean).

To understand how, ever heard of a Rube Goldberg Machine? It’s an unnecessarily complex device for doing something simple. Cartoonist Reuben “Rube” Goldberg turned his own name into a rubric for obtuse machination with humorous creations like the self-operating napkin.

So your stock rose sharply for no apparent reason. Some will say it’s because David Tepper, who made $2 billion last year on a belief in strong equities, said on CNBC that “shorts should get out the shovels because they’ll be buried.”

But the answer to why your stock and maybe your sector yesterday moved, and how Dodd-Frank is a factor may be more like a Rube Goldberg Machine. MSCI global indexes rebalance today, and ahead of that we’ve seen surging high-frequency trading, telling us money is benchmarking ahead to equity indexes at newly higher rates. Options expire tomorrow and Friday, with VIX volatility instruments lapsing May 22, giving arbitragers better opportunity to pairs-trade.

And Dodd-Frank’s deadlines on swap-clearing rules take effect in June, so this is the last pre-central-swap-clearing options-expirations period, which set dates for swaps too.

Ever heard of single-stock futures? It’s a way to go long or short shares without buying or borrowing. There’s even an exchange called OneChicago owned by the Chicago Board Options Exchange, CME Group, and Interactive Brokers, for electronically trading these contracts where two parties agree to exchange a set number of shares of a given stock in the future at a price determined today. Also popular are Narrow-Based Indexes – futures contracts on a small set of securities, say, from an industry or subsector. (more…)

A Short Story

Happy New Year! Boy, where to begin. With the Fiscal Cliff arrayed theatrically as the curtain rises on 2013, it’s a crapshoot picking what to write in the program notes.

So we’ll take aggressive short sellers. No, we don’t mean market Sentiment favors shorts. As December concluded, Sentiment Indicators for 15 client stocks comprising a market sample included two Negatives, three Positives and ten Neutrals. If it were a political poll, the data show your candidate ahead slightly.

Plus, the dollar is about where it started 2012. The Dow 30 were up 7%. Last year’s Gross Domestic Product (the sum of personal consumption, private investment, net exports and government consumption) likely rose about 2%, while the money supply was up 6%, meaning consumption will cost more, which means 2013 GDP, 92% dependent on personal and government consumption, has a good shot at rising.

So things look good if you don’t scrutinize economic structure (if money in circulation is rising faster than output, growth is a bit of a pyramid scheme).

Which brings us to our short story. Did you hear about Herbalife? Activist William Ackman of Pershing Square, not typically a guy who shorts stocks (borrows and sells them in hopes price declines so shares may be returned at a lower cost, producing a gain), targeted the NYSE-listed network-marketing purveyor of supplements with a public attack precisely as monthly options expirations and quarterly index rebalances were occurring December 19-21.

Ackman called the firm’s sales-recognition practices a pyramid scheme. We can’t assess the merits of his argument. But we want to begin 2013 with a lesson on structure – of the market.

Look around at noteworthy “short attacks,” we’ll call them. Often they happen during monthly options-expirations. Maybe it’s planned, maybe not, but the effect is simple to understand. Big money doesn’t invest today so much as it manages assets and risk. (more…)