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Chris DeMuth Jr. is the founder of Rangeley Capital LLC. Rangeley is an investment firm that focuses on event driven, value-oriented investment opportunities. Rangeley Capital and his value investing forum, Sifting the World (StW), search the world for misplaced bets. Rangeley exploits them for... More
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  • Every Little Thing Gonna Be All Right? 29 comments
    Aug 7, 2013 4:42 PM | about stocks: TVIX, VXX

    Bob Marley Regarding Volatility in 2013

    "Don't worry about a thing,
    'Cause every little thing gonna be all right.
    Singin': "Don't worry about a thing,
    'Cause every little thing gonna be all right!"

    I am not so sure. The logic appears circular and the evidence dubious.

    We have been net short volatility from the first half of 2009 to today with an explicit short on various volatility-based securities starting in the latter half of 2011. While I still believe in the intrinsic flaws of the volatility-based securities that we have shorted in the past, we are closing out this thesis and winding down the related positions. Nothing leads to instability like the appearance of nominal stability and we expect that there will be significant mean reversion in the CBOE Vix index in the period ahead. There is a real chance of a new recession beginning in 2014 and we will have little monetary or fiscal flexibility as we face that possibility. Serious threats to international stability rise daily with little concern in the capital markets. In many respects, valuations appear similar to those in 2007. That suits us fine as we found many of our best investment opportunities in 2008. However, that requires that we enter such a period with strong hands and plenty of liquidity and fortitude. Such preparation begins today. To that end, we will be downgrading strategies that are short volatility (such as VXX and TVIX shorts via equities and options) and focusing on those that are long the volatility that we anticipate ahead.

    Stocks: TVIX, VXX
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Comments (29)
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  • mhager1022
    , contributor
    Comment (1) | Send Message
     
    Could't agree more. Went all in long UVXY just this week.
    7 Aug 2013, 04:59 PM Reply Like
  • toddro
    , contributor
    Comments (224) | Send Message
     
    "focusing on those that are long the volatility that we anticipate ahead" - care to expand a bit?
    7 Aug 2013, 06:59 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » We think that it would be reasonable to expect mean reversion. We are shifting into event driven opportunities that benefit from volatility.
    7 Aug 2013, 08:02 PM Reply Like
  • Allen A
    , contributor
    Comments (42) | Send Message
     
    Care to elaborate on what kind of event driven opportunities might profit from increased vol?
    8 Aug 2013, 01:37 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » I guess that the easiest example is owning puts and calls related to deal securities instead of writing them.
    8 Aug 2013, 06:55 AM Reply Like
  • toddro
    , contributor
    Comments (224) | Send Message
     
    Reminds me of the term "financial engineering" which has always intrigued me since it first caught my eye...

     

    http://bit.ly/13l5MLY
    7 Aug 2013, 10:08 PM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1352) | Send Message
     
    Chris-I get your thesis for the most part. With volitility this low the risk/reward may make sense to buy the volitility instead of selling it (though I'm not sure it ever makes sense to buy volitility on double and triple ETF'S). How long of a timeframe are you anticipating? If the vix popped to 20-plus would you unwind or are you thinking that a major market downwave will take the vix into the 40's or somewhere in the 80's neighborhood which would be another 2008-2009?
    Why do you say 'related to deal securities'? Are you thinking since deals usually have super low volitility the options on them can be bought for a song? But almost all deals close.
    8 Aug 2013, 09:01 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » It never makes sense to buy volatility on double out triple ETFs. I am thinking about the next year. I think that another 2008-2009 is more likely than is currently priced in the market. Yes, we have had some luck this year on overbids and bumps. Options on super low volatility deal stocks, especially those at inexpensive prices, can be bought here.
    8 Aug 2013, 09:57 AM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1352) | Send Message
     
    thanks for responding Chris. So just so I understand are you talking about puts (with the thought that the deal may not happen such as ARB or calls (with the thought that the deal will close as most do and with super low vol the calls can be bought cheap creating leverage such as CTB. Or both.
    8 Aug 2013, 10:22 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » Both. There are deals with more risk than the market attributes (ARB for one example) and deals with less and/or more embedded optionality.
    8 Aug 2013, 10:26 AM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1352) | Send Message
     
    I agree. Are you also saying that overbids and bumps will become more common? Seems like the last six months have seen these situations more and more often
    8 Aug 2013, 10:52 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » Yes. That is my expectation.
    8 Aug 2013, 11:13 AM Reply Like
  • Monolith Investments
    , contributor
    Comments (127) | Send Message
     
    "Nothing leads to instability like the appearance of nominal stability"

     

    The 'nominal stability' has existed for quite some time now (since the start of QE1). What makes you so cautious at this point in time?

     

    "In many respects, valuations appear similar to those in 2007."

     

    What data points are you looking at ? P/E and P/B multiples for a basket of stocks?
    8 Aug 2013, 11:10 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » The largest investment that we ever made was in senior secured bank loans in late 2008 through early 2009. They had almost no volatility from 2006-2007 before collapsing to attractive prices. We see a similar situation in equity today. As for data points, we primarily look at price to cash flow from operations. However, we also are concerned that corporate profitability will probably revert towards the mean.
    9 Aug 2013, 10:42 AM Reply Like
  • Monolith Investments
    , contributor
    Comments (127) | Send Message
     
    Thanks.
    9 Aug 2013, 03:17 PM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1352) | Send Message
     
    Chris, since you brought up going long vol with deal stocks......here are some thoughts on potential overbids.......

     

    SKS could get a higher bid. It has traded over its deal price of 16 for 7 straight days and got as high as 16.21. Can grab some at 16.05 or so most days.....

     

    SFD Starboard has been saying since the deal was announced that 34 was way too low.................

     

    DOLE 12 offer. Murdock has taken company private once before. He's 90 so he doesn't have all day to haggle...................

     

    ALCS read Whooper's piece. VERY convincing arguments................

     

    LVB since buyout was announced the stock has not ticked below the 35 dollar bid even once. It has traded over 37. Samick owns a chunk already and is rumored to bid......................

     

    ASI got a bump yesterday to 30.25 but market doesn't think that is enough to seal the deal................

     

    BLC 13.75 has traded over deal price since day 1.

     

    I am long DOLE, SFD and ALCS. Though I think having money in all of these kind of makes sense.

     

    Are companies saying ' best and final' and nobody believes them anymore? Or are investors blindly bidding takeover stocks up in hopes of catching a bump?

     

    Chris would love to know your thoughts.

     

    Eric
    10 Aug 2013, 01:15 AM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » Eric,

     

    There are some very good thoughts here. I am long the same ones you are and have looked at the others. I have not found the SKS value to be convincing. I owned a bit of LVB, but it is not that liquid. My preference is to get some spread, even a small one, instead of paying through for a bump. Happily that worked for OUTD, ES, PCS, AM and DOLE so far this year. What next? ALCS is probably the most auspicious.

     

    - C
    10 Aug 2013, 08:30 AM Reply Like
  • Special Situations and Arbs
    , contributor
    Comments (1352) | Send Message
     
    Thanks Chris. So I write this and go on vacation for a week. I return and look what I missed

     

    SKS reported lousy earnings and now trading 10 cents below offer. Still no position. But even if there is a 10 percent chance of a bump it may make sense to own as the deal is not likely to fall apart so 10 cent gain or small chance of bump vs very small chance of merger failure. Deal was done largely for real estate.

     

    SFD-holding this one to completion. Not expecting Starboard to have any success on getting a higher price but never know.

     

    DOLE Was happy to see an overbid here. Still holding. There is a go shop but also not expecting someone else to enter

     

    ALCS This bump was also nice (Thanks Whopper). I sold some at 14.80 yesterday but still thinking another bump is possible. Market thinks that too for what that is worth.

     

    LVB Here was one I wanted to be in but didn't pull trigger. Can't win them all. Still Samick which owns a chunk already may come over the top. Chris does this feel like that Dell/HPQ battle for 3 PAR a few years ago?

     

    ASI also had news. Fun here is done. Glad I avoided

     

    BLC the only stock here with no real news last week

     

    We can add ONXX to the mix. For someone with conviction the options market is loaded with volatility in this name, especially the front months. Being short puts makes sense (that is my position, though fairly small).

     

    As always anxious to get your take

     

    Eric
    20 Aug 2013, 02:44 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » LVB: In answer to your question, "yes" and it is a dynamic in which someone typically overpays.

     

    ONXX: Yes, I have written $115, $125, and $130 Sept. puts myself.
    20 Aug 2013, 02:57 PM Reply Like
  • satan2liberals
    , contributor
    Comments (1204) | Send Message
     
    Finally somebody gets it that past low realized volatility actually sows the seeds of future volatility surprises.

     

    Also it's my theory that govt interventions are the primary drivers causing market behavior to produce "non-normal distributions".
    for example LTCM and Russian default turned previous normal relationships on their heads.

     

    12 Aug 2013, 11:06 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » I think that your theory is 100% correct. Government intervention is an unintended consequence generating machine that leads to all sorts of perverse outcomes, inefficiencies, and arbitrage opportunities.
    13 Aug 2013, 08:55 AM Reply Like
  • connellybarnes
    , contributor
    Comments (548) | Send Message
     
    It's unfathomable to me that low "fear" or implied volatility is associated with high company pricing, and high "fear" is associated with low company pricing. It's as if the market is taking everything we know about economics and investing and flipping it upside down.

     

    However, it seems retail investors have mostly been pulling money out of the markets since 2008 so it may just be some big institutional momentum trade that has brought markets so high recently. I suppose those traders of other peoples' money maximize their economic benefit by taking strategies that have generally positive returns with occasional loss of everything.

     

    Or perhaps some underground gnome flips coins to decide the market level? Who can say for sure...
    13 Aug 2013, 01:25 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » As far as your point in the second paragraph, annual comp with no real claw backs make for an embedded rational strategy to make money every 5 years while losing everything once even if it has a negative EV.
    13 Aug 2013, 01:32 PM Reply Like
  • connellybarnes
    , contributor
    Comments (548) | Send Message
     
    Right.
    13 Aug 2013, 01:39 PM Reply Like
  • Chris DeMuth Jr.
    , contributor
    Comments (10228) | Send Message
     
    Author’s reply » With VXX up over 6% and TVIX up over 11% this month since this post, I am hoping to have another chance to set these up at some point, ideally with underlying VIX at late 2011 levels.
    26 Aug 2013, 05:46 PM Reply Like
  • toddro
    , contributor
    Comments (224) | Send Message
     
    Did you read this? Interesting aspect: " Long-Biased Hedged Convexity Captures" - seems like something you would be interested in. I downloaded all 6 parts of how article to try to get to this afternoon and I'm trying to convince myself I might be able to understand his $200 Kindle Book…

     

    http://seekingalpha.co...
    31 Mar 2014, 10:06 AM Reply Like
  • satan2liberals
    , contributor
    Comments (1204) | Send Message
     
    toddro:"Did you read this? Interesting aspect: " Long-Biased Hedged Convexity Captures"

     

    ========
    Yes I read it,and it sounds like the perfect way to lose money:if you don't recognize it as the directional trade that it is.
    31 Mar 2014, 12:15 PM Reply Like
  • toddro
    , contributor
    Comments (224) | Send Message
     
    Well, Prince Mubarak read his book and gave it 5-stars on Amazon ; > / I like the idea, I like the articles from an idea standpoint. Not endorsing the trade. Cheers.
    31 Mar 2014, 10:44 PM Reply Like
  • satan2liberals
    , contributor
    Comments (1204) | Send Message
     
    todd
    In all fairness to the author, he did question in his piece how well it might work in the future.
    My advice would be to paper trade it until the returns are an unmitigated disaster... Then it might be time to start with real money.

     

    Because my impression of it's success, is it's wholly dependent upon small cap's long gains and a much lighter play on volatility drag.
    31 Mar 2014, 11:28 PM Reply Like
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