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John Diamondopoulos
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John Diamondopoulos provides commentary on the global financial markets through the MacroTradingEdge blog (www.macrotradingedge.com). He is the chief trader and macro analyst for Optionwhiz HHT Limited (www.optionwhiz.com), a global macro advisory/research firm utilizing option strategies to... More
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  • Emerging Market ETFs - Option Investability Index™

    To capture major and minor market moves in emerging markets, I frequently use ETFs (Exchange Traded Funds) that meet certain standards regarding volume, open interest and liquidity measures (bid-ask, etc).

    Thus, I only trade emerging market ETFs that meet my standards on option investability. For this purpose I have created the Option Investability Index™ - Oii™, which is a proprietary index that rates ETFs and equities on a scale of 1 to 5 (with 5 being the best). The higher the number, the higher your confidence in terms of implementing the appropriate option strategy to take advantage of price movements in emerging markets.

    For example, a score of 3 is fine. But this might be a little risky depending on the option strategy and market conditions, thus you should really look for scores of 4 and 5 to cover most market conditions. It should be noted that during abnormal market conditions, such as during a financial crisis, this might not true and to be on the safe side you might want to reduce the index score by 1 or 2 levels.

    Looking at the table below, you will notice that certain ETFs - (NYSEARCA:EEM), (NYSEARCA:FXI), (NYSEARCA:EPI), (NYSEARCA:EWZ), (NYSEARCA:RSX), and (NYSEARCA:EWY) score very high (4 or 5). These ETFs correspond to the iShares Emerging Markets, China, India, Brazil, Russia and South Korea respectively. You should feel confident in most market conditions with these particular ETFs.

    Also acceptable, but with a bit of caution, are the ETFs of Mexico (NYSEARCA:EWW), Malaysia (NYSEARCA:EWM) and Vanguard Emerging Markets (NYSEARCA:VWO).

    What is not listed in the table below are ETFs from the several countries: South Africa, Indonesia, Turkey, Philippines, Poland, Thailand, Chile, Vietnam and Columbia. Some of these might be OK to use during expected major market moves and under certain conditions.

        
    Emerging Market ETFs - Option Investability Index™ - Oii™
    25th September 2013  
        
        
    Countries and RegionsETFETF nameOption Investability Index™ - Oii™
        
    GlobalEEMiShares MSCI Emerging Markets ETF5
     VWOVanguard FTSE Emerging Markets ETF2
        
    BRICs   
    ChinaFXIiShares China Large-Cap ETF5
    BrazilEWZiShares MSCI Brazil Capped ETF5
    IndiaEPIWisdomTree India Earnings Fund5
    RussiaRSXMarket Vectors Russia Index ETF4
        
    Countries   
    MexicoEWWiShares MSCI Mexico Capped ETF3
    South KoreaEWYiShares MSCI South Korea Capped ETF4
    MalaysiaEWMiShares MSCI Malaysia ETF2
        

    Last week, the FED decision sparked numerous emerging markets. Considering the current account deficits of India, Turkey and Indonesia for example, the risks going forward are growing for these countries.

    A FED decision is expected by as early as the next meeting in October and more reasonably by December. The question is how one might play future volatility in these markets using ETFs as a vehicle. The problem as can be seen in the chart above is that Turkish and Indonesian ETFs are not listed since the score was very low (Turkey) or options were not available (Indonesia). Thus, India seems the better bet in terms of speculating with options on the WisdomTree India Earnings Fund .

    For the meeting in October, a reasonable option strategy is a strangle, which is purchasing calls and puts that are slightly out of money. A medium size or large move in either direction should lead to a profitable trade while also covering the trading costs.

    In contrast a straddle would be more expensive to implement since both the call and put would be at-the-money and trading costs would predominate here.

    The expected FED decision should move markets enough to make a strangle strategy profitable. Since the direction of the expected FED decision in October is less certain this is probably the best strategy.

    If the move does not happen in October, a more directional strategy such as buying a put would be better since you are speculating that the probability of the FED taking action is greater in December.

    Below are visual representations of the two option strategies.

    (click to enlarge)

    Source: pload.wikimedia.org/wikipedia/commons/thumb/2/2a/Long_strangle_option.svg/500px-Long_strangle_option.svg.png

    (click to enlarge)

    Source: en.wikipedia.org/wiki/File:Long_put_option.svg

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Sep 26 5:43 PM | Link | Comment!
  • FED Media Leak And High-Frequency Hedge Funds?

    An article yesterday, (FT: 'Fed probes for leaks ahead of policy news,' September 24, 2013) brought up a possible serious allegation that the FMOC decision on monetary policy last week might have been leaked someone in the media. The FMOC decision is made known to the media from 1:50 pm ET in a locked room in Washington and all parties are prohibited from making any information public before 2:00 pm ET.

    High-frequency hedge funds trade in very short time frames of milliseconds. The article quoting Eric Hunsader, founder of Nanex, implies that it takes 5 to 7 milliseconds for the information to travel from Washington to New York and Chicago, where data showed unusual asset price trading and movement at exactly 2 pm ET.

    Thus, someone leaked the information internally and gave high-frequency hedge funds an unfair advantage. This will no doubt add to the political debate about high-frequency hedge funds on regulation. In fact, the article mentions that the New York attorney general under the Martin Art has agreed with Thomson Reuters to stop the practice of selling access to the University of Michigan Survey of Consumer Sentiment two seconds prior to the release. Of course, high-frequency trading firms benefited from front-running releases.

    The profit potential for high-frequency hedge funds is very large since they take advantage of very small price differences that happen in milliseconds. Since the FMOC decision resulted in a large move of asset prices, these hedge funds which use high amounts of leverage would have made a substantial return in a few milliseconds.

    Note that the time scale here is in milliseconds and the information leak time interval could only benefit high-frequency hedge funds. The question posed then is that could there be other types of leaks internally but of much longer time intervals to other market players. This would have to come from the staff of central banks, not the media as in this particular case. An additional question would lead us to consider the possibility that different types of leaks could occur in other markets globally.

    Anyways, let's wait to see the outcome of the investigation.

    Impact on Your Trading

    • Regarding trading, this is an additional risk to consider. We can call this the 'front-running release risk' and the magnitude of the risk will depend on the importance of the information and the time interval. As an individual trader this would mostly affect you indirectly since you might have accounts with institutions, such as mutual funds and alternative investments such as other types of hedge funds.
    • The direct affect will be that the dynamics and progress of the trading patterns will now be different. But this is probably a small affect since the time scale is in milliseconds.
    • The main issue here is the potential implications of different types of leaks, as discussed above, which could originate from the staff of central banks either in the US or globally. These types of leaks would occur during a larger interval and pose a much greater risk for markets and the credibility of central banks.

    Source: FT (Financial Times): Robin Harding, Kara Scannell and Arash Massoudi, 'Fed probes for leaks ahead of policy news,' September 24, 2013

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Sep 25 5:44 PM | Link | Comment!
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