Fin

Playing the Bust, Understanding the Boom

Like the author I have been playing the short/long strategy on the financial index since late August when the syndrome began, using Proshares SKF and UYG as the ETF tools. The syndrome consisted of strong downward bias with occassional offsetting upward spikes, prior to and immediately after positive announcements for the financials, such as Fed fund cuts, Bank of America announcing their intention to purchase Countrywide etc.

The simple strategy was to keep SKF most of the time, but to immediately sell SKF, and simultaneously buy UYG in anticipation of, or less desirably, in reaction to, positive news in the market discussed above.

Exteme examples of this included the Tuesday morning following Martin Luther King day, immediatley after the Fed made their unscheduled announcement to cut rates 75 bais points, prior to the market opening. Implementation of a premarket SKF/UYG switch immediatly after this announcement and well before the market opening produced the single largest 24 hour gain utilizing this strategy. Another big day occured when BofA announced their intention to purchase Countrywide. While this announcement was impossible to predict, it coincidentally occurred on the same day as a scheduled Fed announcement to cut rates, so if you followed the strategy, you would have enjoyed a very nice day with UYG.


Questions ?

Are the financials close to a "local minimum" or temporary state of equilibrium ? I think so and therefore the fun may temporarily be over. Spikes are decreasing in amplitude and we may be headed towards a slack tide here. Notwithstanding if this is true, then there likely will be a strong buying bias in the not too distant future. If so one can play the same game in reverse i.e. keep UYG most of the time and simultanesouly switch to SKF if/as bad news occurs.

The basis for the syndrome and stategy was: People act emotionally and believe what they hear in the media. More specifically people quicly panicked in mid August when the press went absolutely insane bashing Countrywide to sell news (most of which was either false or misleading). This caused investors to panick losing untold billions in the market. The news and panic quickly spread throughout virtually all mortgage lenders, banks, brokerage houses, insurance companies, real estate companies, and the real estate market in general (virtually every company listed in the financial index) thus creating the syndrome and the strategy.

Thoughts ?

Are we at or very close to a temporary state of equilibrium for the financials ?

Was this a legitimate arbitrage likely to repeat or simply a very lucky speculative set of investments ?

If this was an arbitrage, will it be much more difficult playing in reverse when value based financial buying begins i.e is the emotion of investor greed (effective for the reverse strategy) much less powerful versus the emotion of investor panic which was the basis for the current strategy discussed above ?