Well after the big sell off the previous day, we get a rally yesterday – go figure – volatility is still the number one game in town. The VIX and VXN are moving around like a Dot.com stock of the late 90s – god knows how any market marker is able to get a handle on pricing.
I heard Jim Grant (Grant’s Interest Rate Observer and editor of Security Analysis) , on CNBC this morning. He made and interesting observation – that many investors have misunderstood inherent risk in the markets and there are some convertible bonds that trade at a steep discount to the underlying on relatively solid companies as compared to Treasuries – which pay very little interest, but has inherent risk through the massive debt (and deficit spending) the government continues to drive. It’s a very interesting observation and as the other guest (Jack B. – Mr. Perma-Bull) said “The world is upside down” when he describes Jim’s observation. Technically – Jim is saying there is MORE risk in Treasuries than in some other investments. He seems to very concerned about the dollar. You can see the video here http://www.cnbc.com/id/15840232?video=948828553
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ADP Job numbers
The ADP numbers precede the Government job numbers and usually give us a fairly decent idea of what to expect from the government numbers. Unfortunately the ADP numbers showed a elimination of 250,000 jobs in November (OUCH!) The drop was larger than forecast! The financials and automotives lead the way in job cuts and companies are in save money and cost cutting mode – hence the shed of jobs to cut overhead.
Note: ADP includes only private employment and does not take into consideration hiring by government employment agencies. I guess you could say if we see the government numbers significantly lower than the ADP – then the government must be on the hiring train. I wonder if AIG, Freddie, and Fannie (if they hire jobs) if that is considered government or not? Just kidding – for those that might of missed the socialistic new deal joke.
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Big 3 Pow-Wow today
Pelosi last night pretty much told the world that Bankruptcy is NOT an option and that the Big 3 are getting the money they want. Now it comes down to “from where”. The TARP, Special Loan, Uncollateralized Fed, etc. Her brother-in-arms, Reid, is already drafting legislation for Monday and you can bet, just like the big bailout bill that by the time it gets voted on it will be back-loaded with earmarks and more pork. I wonder if Nancy is going to add another $30 million for the American Samoans Enlightenment, that happen to be employed by Star-Kist (head quartered in her home state), owned by Dole, which she waved them from having to meet minimum wage, in which her husband has a $2 million dollar investment….hmmmmm. Of course we can all expect to hear Ron Paul – poke holes at it and vote no.
GMAC got ahead of the curve to apply for bank status – to get access to that discount window. Too bad the Big 3 can’t. However, I wouldn’t be surprised to see the UAW become a new government agency – supported by the taxpayers. Maybe all of us NON-UAW can pay their dues.
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Interesting Delta Problem
Yesterday a trader using our system had a reversal on (short put, short stock, long call) – most of the time you just ignore deltas. It was contract neutral and technically his only risk is RHO (interest rates) and Short (called away). Typically deltas on such a position are considered FLAT (+/- a couple hundred – depending on if you are running bid/ask/mark for calculating volatility to solve for delta). However, he pointed out something very interesting – his position was showing short -5,000 deltas. That seemed very wrong. I glanced at his position – sure enough he had on two reversals – I expected to see +/- a couple hundred deltas, but not -5000 deltas. I looked at the stock, it was GM. Then something interesting – the PUTS are running at 400+ volatility, while the calls are running at +200 volatility.
I point this out for two reasons, first many forget that option Greeks can be greatly impacted by volatility. In terms of delta – the higher the volatility you run the more it pushes deltas towards 50 (OTM options increase in delta, because of the higher chance of becoming ITM, and ITM options decrease in delta, because of the higher chance of becoming OTM). While lowering volatility pushes deltas away from 50 (OTM option decrease in delta, because of a lower chance of becoming ITM, and ITM option increase in delta, because of the higher chance of remaining ITM). In GM’s case the PUTs have a higher volatility than the calls, especially the OTM put options. If you are running your deltas off the current implied options (rather than a flat line or interpolated model) you will see a big discrepancy in deltas.
The second reason is it reflects the market expectation for GM is for a high possibility for the company to file chapter 11 (downside risk) OR people need to hedge their positions and are over paying for insurance. The puts are extremely overvalued compared to calls, add in the hard-to-borrow for many and the only option instead of shorting is to buy puts.
This is a very interesting example how options can not only mess with ones positions (and give misleading risk measures) but at the same time reflect expectations in the underlying.
As I pointed out – GM needs $4 billion TODAY – otherwise they could be facing bankruptcy by yearend. The options reflect that and also reflect that not ALL of Congress is on board with a bailout.
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Futures Pre-market
They are getting hit hard – as the ADP numbers did NOT look good. The spreads are widening, but ARB traders are sideline because they don’t want to buy futures and risk trying to get off short stock.
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Support / Resistance
Well we moved up in some cases to those pivot points (which look to push the stocks back down according to the pre-market futures action)
INDU 8000 (8500) 9000 (We got close to the 8500 pivot point level – do we revisit the 8000 support?)
NDX 1000-1100 / 1200 (Again above the higher support level)
SPX 800 (850) 900 (Right at that pivot point – which has the bears pushing it back down)
RUT 400 (450) 500 (Again right there )
It looks like a revisit to the supports today – based on the opening – but it is anyone’s game.
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Conclusion
The market as Jack said “The world is upside down” referring to Jim. What seems safe (treasuries) may not be safe, and what seems risky (convertible bonds) may be more safe. He has a point, the lemmings are rushing to what they HOPE is the safe place – but that too is becoming questionable. The dollar sees more and more stress each and every day – and while true it IS remaining strong today – doesn’t mean that it will tomorrow.
Please hedge yourself.
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