April 20, 2010

Goldman Sachs or Expirations?

We hope none of you are marooned in Europe by volcanic ash. If you are, we’ll try to keep your minds off the extra money you’re spending with the shocking suggestion that markets writhed last week not for Goldman Sachs but for expirations.

The SEC last week sued Goldman Sachs for misleading investors about certain collateralized debt obligations during the subprime mortgage meltdown. We’re not a news rag so we won’t regurgitate the facts and accusations. We’d observe, as did a fine Wall Street Journal blog at Deal Journal yesterday, that the investors supposedly mislead were the world’s most sophisticated CDO investors, that Goldman lost money, and that the disclosures about these swaps that always require two parties with opposing expectations of outcomes were of monolithic proportion. Up to and including acts of God, everybody party to them knew the outcome could be good, bad or ugly.

Which leads to trading last week. Options expired April 15-16 when markets gyrated. Markets were up a hundred points the day before, April 14, then down a hundred points. Today, April 20, volatility futures expired, and short-term trades between stock and index options last week and volatility moves today could pay with little time decay or risk for the savvy trader. There was actually more fundamental buying on April 14, the up day, than fundamental selling on April 16, the down day, data indicated. It’s not always about the news. There is no better proof than what happens under the skin of the market with monthly expirations.

So what’s it mean? Market structure tells us that money thinks the Goldman accusation is hooey.  And speculators were taking advantage of disruption in the markets around expirations. It’s been a fantastic run in the markets since expirations in March when we told you that risk hedges were perhaps the largest we’ve seen. Traders bet big on equity gains from March 19 to April 16, and the move paid off. And the dip on April 16 had little to do with Goldman Sachs.

We promised examples about using market-structure analytics, so we’ll leave you with one. Before its analyst day recently, a large public company wanted to set expectations. We could see reticence on the part of active money to pay up for shares. Speculators were working hard to foster intraday trading ranges, which meant that investors had uncertain views (speculators often know). Thus, meeting expectations alone would be positive, despite high expectations this spring for outperformance.

The stock rose a dollar the following day. Real or Memorex? Often, traders create momentum around analyst days – not difficult in this age of anonymity and electronic trading. But data showed that real money indeed paid $0.75 cents more. Price held up even during the recent market pullback.

It’s darned cool in the IR chair not having to guess if your trading activity is real or noise. As is using that information to make management wonder how in the world you know the stuff you know.

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