Surly Trader

Equity Market: Expect the Unexpected

Thanks for the comment.

I can and often have views on whether I believe market levels are *rational* or not, but I cannot say how long a market rally can persist or how far a market can go down. Because of that, I will never fight the market's direction. I think that the biggest mistake that traders and investors make is when they become convicted in bullish/bearish views and only looks for news or signals that confirm their positions. Again - Markets can stay irrational longer than you can stay solvent...


On Dec 09 10:22 AM Moon Kil Woong wrote:

> Surley Trader, thanks so much for making an argument about volatility
> and not the direction. It shows the level of astuteness that you
> have over so many others in this market who could benefit from reading
> this.
>
> I am less amazed that the current market rally as much as the associated
> volatility it implies. Thanks for the historical context. Like you,
> I don't expect volatility to drop anytime in the near future. 2010
> is shaping up to be a wild ride, be it up, down, or side to side.

Dubai - A Crisis of Confidence

I will be sure to add debt/gdp and overall gdp on the next one. Wanted to get the article out there before it lost its timeliness. The key to much of financial investing is constantly being on the look out for the next proverbial shoe to drop. I am not stating that these things *will* happen, but the slope an be awfully slippery.


On Nov 30 08:35 PM I'm too Complex wrote:

> ST, again a good article.
>
> I agree with you on the fact that people who deem Dubai as being
> 'small enough to fail' don't realize the systemic effect it could
> trigger.
>
> Rising concerns regarding sovereign resilience could entail a negative
> feedback loop. Bear Stearns thought it was financially viable before
> investors lost confidence in the firm's liquidity and it started
> to face margin calls.
>
> Historically, sovereign debts have followed credit crunches. Your
> table also shows that only did Sweden and Norway see CDS Spread tighten
> (by a mere -3 and -1%). It would be interesting to have on that same
> table the size of the different economies.
>
> Herd behavior could trigger a jump in spreads as the one observed
> on August 9th 2007 between overnight rates and the Fed Target Rate.
> This could be damageable for a lot of states.
>
> Thx again,

Dubai - A Crisis of Confidence

I will be sure to add debt/gdp and overall gdp on the next one. Wanted to get the article out there before it lost its timeliness. The key to much of financial investing is constantly being on the look out for the next proverbial shoe to drop. I am not stating that these things *will* happen, but the slope an be awfully slippery.


On Nov 30 08:35 PM I'm too Complex wrote:

> ST, again a good article.
>
> I agree with you on the fact that people who deem Dubai as being
> 'small enough to fail' don't realize the systemic effect it could
> trigger.
>
> Rising concerns regarding sovereign resilience could entail a negative
> feedback loop. Bear Stearns thought it was financially viable before
> investors lost confidence in the firm's liquidity and it started
> to face margin calls.
>
> Historically, sovereign debts have followed credit crunches. Your
> table also shows that only did Sweden and Norway see CDS Spread tighten
> (by a mere -3 and -1%). It would be interesting to have on that same
> table the size of the different economies.
>
> Herd behavior could trigger a jump in spreads as the one observed
> on August 9th 2007 between overnight rates and the Fed Target Rate.
> This could be damageable for a lot of states.
>
> Thx again,

Do Black Swans Negate Option Premiums?

I think you might be getting confused from my disclosure which is misleading. My disclosure says that I am short implied volatility and long realized, but it didn't say on what. I am long realized volatility on emerging markets and short implied volatility on the S&P 500. This changes as I find relative value plays, only wanted to disclose that i do have positions in volatility.

To answer your question, if you want to capitalize on what I am arguing for: You sell 1-3 month S&P 500 strangles or straddles (say on SPY). You delta hedge this position daily or when there are decently large moves so that your overall position is "delta neutral" meaning you don't care if the price of the S&P 500 goes up or down. If realized volatility comes in lower than the implied volatility on the call and put that you sold, then you will capture the difference between those two (minus gamma losses and commissions). I will explain these types of strategies in more detail in other posts.


On Nov 25 02:21 PM valueinvestor999 wrote:

> So to profit lets say from this difference - between implied and
> realized - one needs to establish:
> - a short position in implied vol by selling options
> - a long position in realized vol by buying options and delta hedge
> them with underlying asset ?
> So how I make this difference if I bought and sold the same implied
> vol ?
> Can you please explain or give an example of a position on S&P500
> index for example which will benefit from this difference in volatilities
>
>
> Thank you
>
>
> n Nov 25 11:19 AM Surly Trader wrote:

Do Black Swans Negate Option Premiums?

You are correct in saying that the tails are fatter if you held the individual names in the index and did not rebalance. Since we are trading options specifically on the index which is rebalanced (and stocks are replaced) then the spread shown represents actual results.

As for showing these results on individual stock options...it is difficult. I have seen studies from investment banks that show similar results. The problem comes with the immense amount of data and illiquidity of single name options. I can tell you that selling implied volatility on just one or two names is not a good idea ;-) That also means that you need more investable money to implement a multi-single stock delta neutral hedging strategy.


On Nov 25 02:25 PM pacalis wrote:

> This is a very interesting conversation. Adding to "too complex's"
> general comments, I'll suggest that specifically the use of index
> data isn't so much irrelevant as it is misleading. Index data suffers
> from selection bias in that failed firms are adjusted out of index
> data time series... How I interpret this is that more than the tails
> just being fat, the negative end of the tail is necessarily fatter
> than the index data shows. Again this leans towards an argument for
> only "going long" black swans.

Do Black Swans Negate Option Premiums?

Purchase options and delta hedge them.


On Nov 25 09:38 AM valueinvestor999 wrote:

> How do you establish a long position in realized volatility ?

Do Black Swans Negate Option Premiums?

I am glad you enjoyed the article and that it invoked a strong response.

Your points are valid, but I think you might be misinterpreting my conclusion. There *could* be an event that occurs in the markets some day in the future that no person could possibly conceive of. That event could wipe you out as an option seller and the bankruptcy bell will ring. Had you purchased put options you would be touted as the hero and have your face on Trader magazine instead of John Paulson’s. Nassim Taleb purchased his put options repeatedly, and in 2008 they finally paid off. The problem is that I bet that fund will be his first and last successful foray into money management.

I guess I kind of liken it to locking oneself up in his/her house to protect against unknown mortal dangers – I could get hit by a bus, get in a car accident, fall off a building, or get eaten by a rabid dinosaur (Black Swan). Unfortunately, by locking myself up in the house I cannot make a living. I leave all of the profits to the people who seem to ignore the risk of imminent mortal danger.

When you state “Options, if well used, are a cash machine” I think you agree with my sentiment. I think that where we slightly disagree is in our use of Taleb’s Black Swan. In my opinion, it’s a neat academic idea and there is truth in many of his assertions. From a practical sense, when playing the stock market game on a repeated basis, I think it is misleading.


On Nov 25 10:00 AM I'm too Complex wrote:

> Good article.
>
> I think you rightly expose Taleb's thinking on the following points:
>
> - Stock Market returns are characterized by Fat Tails, and thus follow
> an underlying power law.
> - Hence, sigma is an overvalued indicator that cannot be trusted.
> It misses those extraordinary fat tails and the returns/loss they
> entail.
>
> Though, I do not fully agree to the second part of your analysis
> as I think you miss Taleb's point.
> - A Black Swan Event is by definition unex
p
ected. The best we can
> do is hedge against those events. When Taleb says one shall be long
> on options, it is only a matter of the capped loss they provide (even
> if the payoff may be lower than selling options). You may make less
> money than in shorting implied volatility, but you are hedged against
> a potential Black Swan. You're saying Taleb being wrong does not
> make sense at that particular point, as you're target is different.
>
>
> "Nassim Taleb is right in suggesting that large outlier events occur
> in the markets more frequently than many people account for, but
> I think that he is wrong in asserting that put options are mis-priced
> to the benefit of the option buyer."
> Being long provides a good return and hedges you against risk by
> capping your loss. It is almost a head you lose, tail I win situation.
> That's the only reason why Taleb says they are overpriced.
>
> But that point, I think you understand.
> - Then, you bring up Boudarengo's work and I am starting to think
> you missed the Black Swan's point.The Black swan is on its whole
> about Statistical regress fallacy: our belief that the structure
> of probability can be derived from data.
> ie: Believing the future can be derived from the past.
>
> Historical data, as the one you bring up to illustrate your point,
> as one problem. It's historical.Time series analysis is irrelevant
> in the estimation of Black Swans.
>
> Does the fact that over the stock market's lifespan the gap between
> realized and implied volatility was prone to option shorting mean
> that no event could come and erase all this gains?
If you think
> so, prepare for thanksgiving, you are a seating turkey victim of
> confirmation bias.
>
>
>
Briefly, I agree with your analysis, but not with your conclusion.
>
> Options, if well used, are a cash machine. Because mainly markets
> are inefficient. I however do not concur with your
criticism of
> Taleb's "only go long on options" argument. Going long is the only
> viable way to hedge against Black Swans, because of capped losses.
>
>
>

Relative Strength of Countries

The point in making the comparison between the US and other countries is NOT to say that the U.S. dollar will continue to strengthen against hard commodities. In a world of fiat currencies with loose monetary policy, all currencies will weaken against hard assets over time. My point is to bring to light the *focus* on the US dollar as the currency that is going to be destroyed. That focus has played a big part in the fall of DXY. To me it is rational to think that all currencies will weaken over the long run, but to also think that in the short run the focus on the US dollar has caused short term anomalies in the currency markets and certain assets(oil).

The VIX Spike Conundrum

A long VIX position at this point is a bet on a massive market correction looming. It would make more sense to me to short indices rather than go long VIX now from a risk/reward standpoint. Playing with a long position on the vix at 30 is either going result in modrate gains from a small chance of another leg up or a large chance of catching a falling knife. I would rather sell options at these levels and make my directional bets with futures or etf's.

TLT Options: Taking Advantage of Interest Rates

<img class="authors_reply" src="static.seekingalpha.co...">

Futures are generally the most efficient way to hedge. When you buy or sell a leverage ETF they are often using futures as part of their investment program. You do not have a perfect hedging vehicle for your situation available. Two year treasury futures would be the closest match to your 1 year UST exposure (TUZ9). Euro$ futures are probably your best way to hedge your prime (typically fed funds +3%). Basically you need to figure out how much the value of your loans increase against you for every basis point increase in rates, then short the appropriate number of Euro$ and two year futures. The problem is that you end up with a liquidity issue because the futures are mark to market and your loan is not. Plus you technically need to hedge each cash flow in the future, so you should be using a string of Euro$ futures, but that's probably not practical for you.

On the flip side, if your loans are very small then it might make more sense to use ETF's such as the barclays short treasury (SHV) or 1-3YR treasury bond (SHY)


On Nov 01 09:47 PM sgt.red.blue.red wrote:

> I’ve got a couple of commercial real estate loans. Both are adjustable
> interest rate loans. I elected to go with adjustable rate loans
> for several reasons; 1) where we were in the interest rate/business
> cycle when I put the loans in place, 2) in that the spreads over
> the underlying indices, in the case of the Treasury adjusted loans,
> were the same spread no matter the maturity of the underlying index
> ), and, as such, 3) most of the time during the interest rate cycle
> there is a positive yield curve, not a negative one, tipped the scales
> in favor of the adjustable.
>
> I have 2 loans;
>
> The first loan adjusts annually with one year U.S Treasury (adjusted
> for constant maturity) index. Index available on H.15, in IBD or
> WSJ (Tuesday). 1 year UST + 2.625%. So every year, this adjusts.
>
>
> The second loan adjusts with prime (prime + zero) as change in prime
> changes (instantaneous).
>
> I would like to know BEST way to hedge against rate increases, $
> for $, for each of these loans (short side ETF’s, options, LEAP’s,
> futures. etc.). In that they are not large loans, the scalability
> of the hedge (frictional cost) must be considered.
>
> I don’t have any real fear on these things jumping, as I am in the
> money on both loans now. However, if I can find the optimal “hedging”
> instrument (e.g. a 3x short ETF), it would be money in the bank.
>
>

Option Players Not Buying Rally

Implied volatility has dropped significantly from its highs as the market rallied, but after a point implied volatility stopped dropping. Realized volatility was hitting lows of 13% while implied could never break through 20%. That tells you that there is still enough uncertainty in the market that you can expect pullbacks/corrections.

The second part of the article focused more on skew, which is even more supportive of this claim. If option buyers are willing to pay more for puts than calls, then you could argue that they are betting on a decline...not a further rally.


On Oct 17 06:56 PM TLassen wrote:

> Thanks for a great article I just happened to come across today.
> Maybe to late for a response from you.
> Please educate me in interpretation of Implied volatility and Market
> direction. My instinct would tell me the fact that the market has
> rallied dramatically, IS supported by the implied volatility. If
> we had seen IV increasing as the market was rallying I would understand
> your point of the article. Please correct me if I am wrong, but the
> options buyers are exactly 'buying the rally' as expressed by the
> relative IV staying low.
>
> "The second thing to look at is how the market is trading and what
> the option traders are suggesting will happen in the future. If
> you look at the dramatic run-up in the S&amp;P 500 of about 25% between
> July 8th and September 23rd you will see that during that time implied
> volatility (seekingalpha.com/symbo...) initially sold off,
> but has remained flat since about the middle of July and has traded
> in a range between 22% and 30%. This does not mean that the market
> will fall dramatically, but it does mean that option traders expect
> volatility to come back. Volatility can only come back if the market
> corrects and is choppy, not if the market continues to grind higher
> or trade in a mild range"

Where Is the Line Between Conventional Banking and Pure Trading?

The banks should have been broken up and pieces should have been allowed to fail or bought at firesale prices. An article from Greenspan came out today about that - www.bloomberg.com/apps...

Only bringing up Greenspan because I thought it was timely. For some reason every time I bring up his name I seem to get attacked. I do blame the loose monetary policy for a lot of the excess in the system, but I doubt the buck stopped at him.

On Oct 16 12:50 PM Warm_Paw wrote:

> It appears the plan where the Fed dumps money into the financial
> system - while investors like Goldman Sachs reap the benefits of
> the stimulus, still aren't enough to get the banks to a state where
> they can unwind these toxic assets once and for all.
> I doubt the toxic assets have even been dented.
> Goldman has discussed purchasing these assets yet anyone stricken
> with them does not want to sell them at firesale prices for fear
> of the damage to the balance sheet and the mad scramble to increase
> reserves. Now if Goldman believes it can purchase mortgages on pennies
> to the dollar and that the real estate market will just jump back
> to the 2005 era, they're delusional.
> Unemployment, govt defecit and the loss of billions of dollars of
> market value are going to keep that from happening.
> The pre 2005 easy money era was stoked by crazy lending practices
> and if we repeat that mistake again the next hit will be hell to
> pay. The govt is creating legislation to make lending practices accountable.
>
> The govt should never have bailed out anyone and let a free market
> system correct itself. The destruction of what doesn't work into
> the rebuilding of that which is more efficient and stronger.
> Because the govt has subsidized the crooks going against logic and
> the natural order of such events in financial systems, the economy
> is going to hang in limbo, on life support, until a time when the
> next waves of destruction reset the financial system to a base level
> which is then ready to build itslef up from the ashes.
> It's inevitable.

History of the Dollar's Devaluation

I do not disagree with your statement, but the regular middle class citizen should not have to worry about hedging their savings against the taxation of inflation. It's a dishonest tax from a dishonest government.
If you have read many of my posts on my own blog I am very much critical of the actions that Greenspan took and I do believe the actions are a major contributor to the mess...but I honestly do not believe that it was his choice, but the choice of spend-happy politicians.


On Oct 15 01:15 PM djj420 wrote:

> “In the absence of the gold standard, there is no way to protect
> savings from confiscation through inflation. There is no safe store
> of value. If there were, the government would have to make its holding
> illegal, as was done in the case of gold…. The financial policy of
> the welfare state requires that there be no way for the owners of
> wealth to protect themselves.“
> - Alan Greenspan
>
> Pardon my French, but Greenspan is a pinhead. With the wide array
> of financial products available today, you can very easily fashion
> your portfolio to be as uncorrelated to the US$ as you wish. I'm
> hardly an expert, but I've done pretty well for myself as the US$
> has declined. Greenspan led the economy thru an unforgivable series
> of bubbles; and Bernanke has followed in his footsteps with a long-dated
> treasury bubble that will likely soon rival Greenspan's tech, housing
> and credit bubbles in the ferocity of its unwinding.

History of the Dollar's Devaluation

“In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value. If there were, the government would have to make its holding illegal, as was done in the case of gold…. The financial policy of the welfare state requires that there be no way for the owners of wealth to protect themselves.“
- Alan Greenspan


On Oct 15 09:56 AM Bull Run wrote:

> The Fed has had a long history of Not protecting the US dollar, but
> as long as it maintains a world currency status, America will enjoy
> a free ride.

Option Players Aren't Buying the Rally

I have not seen the Ansbacher index listed anywhere on the web. In fact, I have only found a handful of useful articles on Ansbacher in general.

As for academic reseach, start with:
Bondarenko, Oleg, Why are Put Options so Expensive?, May 2004
Santa-Clara, Pedro and Saretto, Alessio, Option Strategies: Good Deals and Margin Calls, January 2006
Driessen, Joost & Maenhout, Pascal, A Portfolio Perspective on Option Pricing Anomalies, October 2004


On Oct 04 11:14 AM MILESCFA wrote:

> On Oct 02 03:56 PM Surly Trader wrote:
> ... Check out information about Max Ansbacher....