Tagged: Options Expirations

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…)

Stocks and the Fiscal Cliff

CNBC has a Fiscal Cliff countdown clock.

You can’t click a TV remote or a web page without somebody declaring that Congress’s inability to compromise on tax rates and spending cuts before December 31 will incinerate equities.

It’s predicated on sound logic. Higher taxes on investment behavior are likely to impact that behavior negatively. Motivation.

We here in Denver before we found the Holy Grail – Peyton Manning – hailed Tim Tebow, who famously sent a one-word tweet after Eli Manning’s Giants topped the Patriots in last year’s Super Bowl: Motivation.

If what one expects will happen isn’t aligned with motivation, then what one expects is unlikely to occur. That’s true in police work, business, life-goals – nearly everything. Including the stock market.

Suppose I expect that because you are a football fan you’re likely to be at Hanson’s Pub near 6:30 p.m. Mondays in Denver for the weekly NFL game. If “you” means my wife, who likes “Johnny Football” Manziel at her Alma Mater Texas A&M but doesn’t give a hoot about the NFL, my expectation won’t match reality. Monday Night Football does not motivate her.

What motivates the market? Many pundits (not all!) conclude that markets will behave badly unless a deal is in the works. That would be true if money in the markets were all rational. But statistically, Rational Investment – money following fundamentals – is only 15% of daily volume across the major US markets. Technically, we peg it at 14.2% the past 200 days, a bit more in the past five (exactly 15%). (more…)

Relativity and Dollars

How do you prove relativity?

When Einstein proffered the preposterous suggestion that all motion is relative including time, people clearly had not yet seen Usain Bolt. Or what happens to stocks after options-expirations when the spread between the dollar and equity indexes is at a relative post-crisis zenith.

Let me rephrase that.

As you know if you get analytics from us, we warned more than a week ago that a reset loomed in equities. Forget the pillars on which we lean – Behavior and Sentiment. Yes, Sentiment was vastly neutral. Behavior showed weak investment and declining speculation –signs of dying demand – all the way back in mid-August.

Let’s talk about the dollar – as I’m wont to do.

There is a prevailing sense in markets that stocks are down because earnings are bad. No doubt that contributes. But it’s like saying your car stopped moving because the engine died, when a glance earlier at the fuel gauge on empty would have offered a transcendent and predictive indicator.

Stocks are down because money long ago looked a data abounding around us. From Europe clinging together through printed Euros, to steadily falling GDP indicators in the US and China, to the workforce-participation line in US employment data nose-down like it is when economies are contracting not recovering, there were signs, much the way a piercing shriek follows when you accidentally press the panic button on your car’s key fob, that stuff didn’t look great.

We know institutional money didn’t wake up yesterday, rub its eyes, and go, “Shazzam! Earnings are going to be bad!” (more…)