Not in Kansas Anymore: Recession, Economic Data and Margin Rules - Oh My!

by: Philip Davis
Alan Greenspan says we may be heading into a recession.

This is not something you want to hear to start the week but the markets are probably more comfortable hearing him get back to his usual "doom and gloom" prognosis than they have been with his recent "housing may be bottoming " BS that he’s rolled out as his last few appearances.

Super Market

Greenspan getting optimistic about housing is sort of like Darth Vader asking you over for tea - you’d like to think he’s really changed, but you still have trouble really getting comfortable with the situation.

We like our bad guys to be bad and our bears to act bearish - then we all know our place in the world and can act accordingly - it’s way too confusing when people start switching sides!

It’s a very busy data week so we’ll see how sharp Mr. G’s forecasting skills are as we get some biggies. Here’s the list from

Date Time Release For My Target Briefing Consensus Prior
Feb 27 08:30 Durable Orders Jan -2.7% -3.0% -2.0% 2.9%
Feb 27 10:00 Consumer Confidence Feb <108.0 109.5 109.0 110.3
Feb 27 10:00 Existing Home Sales Jan 6.10M 6.30M 6.24M 6.22M
Feb 28 08:30 GDP-Prel. Q4 2.7% 2.5% 2.3% 3.5%
Feb 28 08:30 Chain Deflator-Prel. Q4 1.5% 1.5% 1.5% 1.5%
Feb 28 09:45 Chicago PMI Feb <50.0 50.0 50.0 48.8
Feb 28 10:00 New Home Sales Jan <1085K 1085K 1090K 1120K
Feb 28 10:30 Crude Inventories 02/23 -2MB NA NA 3694K
Mar 01 08:30 Personal Income Jan 0.3% 0.3% 0.3% 0.5%
Mar 01 08:30 Personal Spending Jan 0.5% 0.4% 0.4% 0.7%
Mar 01 08:30 Initial Claims 02/24 335K 325K NA 332K
Mar 01 10:00 Construction Spending Jan -0.3% -0.2% -0.4% -0.4%
Mar 01 10:00 ISM Index Feb <50.0 50.5 50.0 49.3
Mar 01 17:00 Auto Sales Feb 5.0M 5.1M 5.1M 5.2M
Mar 01 17:00 Truck Sales Feb 7.2M 7.2M 7.3M 7.5M
Mar 02 10:00 Mich Sentiment-Rev. Feb <93.0 93.3 94.0 93.3

ISM below 50 is an early sign that Greenspan is on track but hopefully he’s just being his grumpy old self, trying to counterbalance a dovish Fed outlook with a little rain on our parade. He is taking the opportunity to speak out against the deficit, something he was not really free to do as Fed chief but his most interesting statement is that investor appetite for risk has led to risk premiums on financial assets being "extraordinarily low," which could pose problems in the future.

We have extraordinarily low risk premiums now. Risk is no longer perceived as major risk, at least as it was in years past and that, I must say, I find disturbing," he said. "We do not and cannot look into history without being very concerned when you see the absence of awareness and concern about risk that we see today.

Let’s see if that can perk up the old VIX!

This is interesting at a time when margin debt is at a new record but I’ve been mulling over the potential impact of the new portfolio margin rules, which go into effect on April 2nd. On the whole, this should be great for us, as we mainly write covered calls, but it depends how it is actually implemented by the brokers. On the whole, the minimum margin requirement for securities will now be 15% OF THE ENTIRE PORTFOLIO, as opposed to the standard 50% of each security, this means you can buy more than three times more stock with the same money!

Even more significant to large traders and funds is that the collateral requirements now read across your whole account, as opposed to each individual trade. This means that if you diversify your risk (like us) you will not get a margin call on your negative positions if they are offset by other positive moves.

EVEN MORE significant than that is the fact that protective puts will now virtually erase the margin requirements against your stocks. If you take this week’s Kinder Morgan Energy Partners LP (NYSE:KMP) example - currently, if you have $5,000 cash in your margin account, you can buy 200 shares of KMP at $50 each ($10,000). If you protect yourself with puts, this does not change that formula. Under the new guidelines, protecting yourself with five Jan ‘09 $50 put contracts for $2,000 will allow you to buy perhaps 500 shares ($25,000) with that remaining $8,000 - it’s not clear how the brokers will interpret this, but clearly the new regs do not consider your underlying security to be "at risk" when it is covered.

From the CBOE web site, we have these examples of potential strategies we can employ:

These are samples, NOT recommendations!


• Long 500 IBM @ $91.25
- Short 5 calls IBM APR 95 @ $ 2.78

Current margin is 50% of stock less the short option premium or $21,422.50, new portfolio margin requirement is $5,504.00.


• Long 500 IBM @ $91.25
- Long 5 puts IBM APR 90 @ $ 2.50

Current margin is 50% of stock plus full payment for put or $24,062.50, new portfolio margin requirement is $1,878.003


• Long 50 calls IBM APR 90 @ $5.45
- Short 50 calls IBM APR 100 @ $ 1.16

Current margin requires full payment or $21,450.00, new portfolio margin requirement is $19,089.00

NON-CONFORMING DEBIT SPREAD (Long must expire on or after short)

• Long 50 calls IBM APR 90 @ $5.45
- Short 50 calls IBM JUL 100 @ $2.28

Current margin requires full payment for long option and appropriate margin on short option position or $74,750.00, portfolio margin requirement is $14,106.00!


• Long 50 calls IBM APR 85 @ $8.99
- Short 50 calls IBM APR 90 @ $5.45
• Long 50 calls IBM APR 100 @ $1.16
- Short 50 calls IBM APR 95 @ $2.78

Current margin requires full payment or $9,600.00, new portfolio margin requirement is $6,221.00.

NON-CONFORMING LONG CONDOR (All options must expire at same time)

• Long 50 calls IBM APR 85 @ $8.99
- Short 50 calls IBM JUL 90 @ $6.82
• Long 50 calls IBM APR 100 @ $1.16
- Short 50 calls IBM JUL 95 @ $4.12

Current margin requires full payment for long options and appropriate margin on short option positions or $214,500.00, new portfolio margin requirement is $ 4,638.00! That is $209,862.00 less!!!

We are gonna party like it’s 1929, as this is a rollback of laws that were put in place during the great stock market crash in order to prevent this sort of nonsense… Before you start quadrupling you holdings, here’s a great cautionary tale about margin trading in India’s recent rally that should be required reading for anyone looking to leverage their capital under the new requirements!

This will be a hot topic discussion for the next few months, and Sage and I will be working hard to bring you the latest as we will begin to position our portfolios to take advantage of the smartest and safest leverage plays. One thing I am assuming is that this will place a greatly increased demand on puts, possibly raising their value significantly but also possibly flooding the market with open contracts as they roll and flip!