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Tom Armistead
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I'm a well-informed retail investor and post on SA in order to expose my thought process to critical examination and comment from readers. It makes me a better investor. I'm particularly proud of bullish macro articles posted in 2009 and later, in which I presented ideas that encouraged me to... More
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  • Financial Stress Is Rising

    I've been away from an internet connection for the past week, and upon returning I checked the STLFSI (St. Louis Fed Financial Stress Index) and noted that it is rising sharply. Here's a chart:

    (click to enlarge)

    The sharp rise will bear watching. When last I looked at this indicator in systematic way, I observed a visually good negative correlation with market level as developed from the S&P 500 (NYSEARCA:SPY).

    I also grouped one year forward market returns based on the level of the STLFSI, and found that the area from 0.0 to -1.0 could be categorized as a sweet spot, with returns averaging nearly 12%. Below -1.0, returns averaged -0.18, and 0.0 to 1.0, they averaged -3.55%. Some commenters disputed my methodology and conclusions.

    Without updating the original analysis, I look at the current move as a positive. With financial stress as low as it was, there was a distinct possibility of setting up a bubble scenario. With major indexes in the vicinity of a 10% correction, and financial stress at a level that in the past has been consistent with excellent returns, judicious buying may be rewarded.

    If financial stress continues upward on its current trajectory, market levels are likely to deteriorate, causing distress to those who are fully invested, and joy to value investors and bottom fishers who have been holding purchasing power in reserve.

    As far as my personal reaction, I have a hedge that will liquidate 50% if the S&P corrects 15%, and the other 50% if the correction reaches 20%. I plan to deploy the proceeds to accept further downside exposure on existing long LEAPS positions, by rolling down, and any excess would go to adding new DGI type positions, assuming good entry points will be available.

    If the STLFSI gets above 1.0, I will start saying stuff like "Danger, Will Robinson, danger."

    Sep 06 2:18 PM | Link | 3 Comments
  • What To Do With My Hedge

    Last week I was thinking about cashing in my hedges. I own SPY Dec 2016 240 Puts, which are predictable in their behavior and not too expensive from a time premium point of view. I don't like volatility hedges, as popular as they are right now, for the fact that the underlying is ephemeral.

    I knew I would be away from the market for several days, hiking the AT in the White Mountains of New Hampshire, so I decided to put in some GTC sell orders at prices consistent with a 15% or 20% correction.

    They didn't trigger, and I'm planning to take off again this week. Who knows what might happen?

    With half the hedge for sale on a 15% correction, and the other half at 20%, I'm not too concerned about the short-term gyrations. If I come back and they've been cashed in, I will have a profit on the hedge. From there if I can find something intelligent to do the funds will be available in cash.

    My first experience hedging worked out well. Prior to the financial crisis, I had been accumulating long dated OEX puts and rolling them to stay about 10% out of the money. Volatility was quite low and they were very affordable. The underlying S&P 100 had a lot of financials, meaning big banks. So I was hedged in the right way.

    Very regretfully, I cashed the hedge in when VIX hit 35, and well before the bottom. However, the profits were helpful and were deployed into the market at points that look low compared to today's levels.

    That type of hedge isn't economically feasible right now. I've had some success buying OTM puts on SPY or XLF on an opportunistic basis, but results have been uneven because they cost too much and decay too fast. Plus there is always the issue of timing, when to cash them in.

    I'm relatively comfortable with the long-dated deep in the money puts. They behave pretty much the opposite of the underlying and the time cost is affordable. I rolled them up once (from 220), paying $12.67 for a $20 increment, which reduces the time cost.

    It's a source of funds that can be cashed in at a profit in the event of a correction. If the market continues upward, they will pick up time value as the underlying gets closer to the strike. The cost of a hedge that never becomes profitable is fairly predictable and can be budgeted over the time period involved.

    There have been some issues with options bid/ask spreads being wide during periods of high volatility, exactly when trading might be wildly profitable. The GTC orders at least create a situation where I won't be staring at the screen in frustration, trying to get the proper orders in while everything is jiggling around.

    Most of my trades (other than the hedge) involve a vertical call spread. I'm swapping one call for another with the same expiration and a different strike. I don't care how wide the bid/ask is on either of the two legs. My concern is with the difference, and I have rules of thumb about what I want to pay to roll down, or receive to roll up.

    Tags: SPY, Options, Hedging
    Aug 31 8:57 AM | Link | 4 Comments
  • Deere: Over-Reaction To Earnings

    Deere (NYSE:DE) beat on EPS and Revenue, but guided Fiscal 2015 down from $1,900 million to $1,800 million. It works out to 33 cents a share. So the stock is down $6.61 as I type this.

    When last I looked at Deere, I developed the following opinion on valuation:

    So I was using $1,800 million for 2015: that's what the company sees; there is no change from my point of view.

    Part of my position consisted of a vertical call spread, long Dec 82.5 and short Dec 87.5. I rolled the lower leg down to 80.0, at a cost of $1.50.

    I plan to buy Deere if it's below $87.50 in December, so rolling down has the effect of reducing my cost when I ultimately buy the shares.

    Tags: DE
    Aug 21 10:21 AM | Link | 3 Comments
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