Last night on Kudlow, I mentioned I would fade the opening move. We’re not day traders, so I didn’t take my own advice — but its apparent that the market is not happy with the NFP data.
As we mentioned earlier today, yields and equities shouldn’t be moving in lockstep. Apparently, the bond ghouls have awoken from their winter hibernation. The 10 year is a stones throw from 5.00%. Its funny how stocks ignored yields all this time; Suddenly, stocks are finally reacting to the shift upwards yields. 5% yield drives the Fed, attracts cash to CDs and fixed income products, and makes coprorate borrowing more expensive, hurting earnings.
A 5% yield is not a stock friendly number . . .
Over the past week, however, I have been trading (and trading around) some positions; Here’s a few recent ideas:
Since today’s NFP had the potential for causing a big gap, I closed a few trades out earlier this week
-The good move was selling the IBM over $84 on 4/5;
-The bad was closing the short of the QQQQs yesterday (doh!) — it was opened on the Libby news;
-I am long the May $43 QQQQ puts and the VIX calls May $12.50s;
The two newest positions opened are Maylasia and Taiwan: I’ll update this later today
VIX Calls, Trust me
I know most people don’t use the VIX model the way I do. That’s fine. Still, a major signal has been given out of a tight squeeze.(Note: This isn’t a trade recommendation, I dont personally have VIX calls because I have other options. But if you know any
Long EWJ, with May 15 calls written against the position.
Not a recommendation.
Commentary welcome.
Over at Bloomberg, I notice the 30 yr is at 5.04, and the 10 yr is at 4.96.
It’s been a long time since that has happened!
I wonder where mortgages are going to end up next week.
GRL, if I understand you right you have written a covered call on EWJ. Personally, I do not get the logic of covered call writting. It just seems like a bad deal for an investor. You basically are limiting your upside, while still having full downside risk. Just does not sound like a winning strategy to me. But remember I am a long term value investor.
If covered call writting was a long term successfull system, it seems to me there would be tons of mutual funds setup to use such a system.
Wasn’t this the strategy the very questionable Wade Cook use to preach and sell books about?
One last comment I agree with Barry and think Maylasia (EWM) and Taiwan (EWT) are two of the most attractive foreign investments right now. Marc Faber also has recommended them and I am long both.
Covered call writing is ideal for a rangebound market — but it does have risks
I don’t like to trade overseas… how the heck do you know what’s going on over there? Cramer has recently been recommending a lot of overseas plays and it really bothers me. Here’s a guy who admits in his book that he always loses money overseas!
How far do you guys think the 10-year will go? I think it will pop across 5% next week and then consolidate a bit. The 30-year has REALLY sold off. When are investors going to get the picture… INFLATION INFLATION INFLATION.
Not enough people are paying attention to gold… Gold is money and it is signaling BIG TIME inflation. The jokers that say gold has disconnected from its role as a monetary signal are crazy. “It’s different this time,” right?
Plus, I don’t know how inflation expectations can be contained as crude hangs near $70 with no big underlying fundamental reason. Supply is up across the board. The real reason oil and gold are trading so high is excess money creation.
What is amazing to me though, and what I don’t really understand, is why the stock market has seen only a limited amount of gains. Perhaps… (now here’s a scary thought) could excess money actually be holding up the stock market?!
I still only feel safe trading on the short side. My lone play into next week: short AAPL!!! I just got back in today after some magnificent short banging. Whoever engineered that raid is a genius.
There was a similar move on SIRI yesterday but no anecdotal news to help it along…
Covered calls are essentially identical to selling naked puts. Except that they have a higher margin requirement. The transaction costs, liquidity and other such things can be different too, but the basic profit/risk characteristics are identical if you ignore dividends.
There are a lot of covered call funds (sometimes called buy-write funds). Most of them are CEFs and have high yields. OEFs don’t tend to do anything more interesting than buying a bunch of stocks (except for Rydex) which is why they aren’t likely to come out with an OEF based on covered calls. Apparently you can even get tax-managed covered call funds (ETV), though I’m not sure how that could work.
I would hardly use the existence of mutual funds as proof that a strategy is a good idea. New mutual funds are created based on strategies that worked well in the recent past. If anything, the existence of tons of mutual funds using a strategy should be a signal that it is time to stop using that strategy.
and to second BR’s point, covered call writing can be very profitable when you are selling a call on a big goose in the volatility premium. hence the term, selling/buying volatility when referring to option trading. plus just because you sell a call, doesn’t necessarily mean you cap your upside if you simply take out a the excessive volatility premium (due to some event like earnings surprise, short squeeze or legal victory) or time premium.. if at expiry you are in the money, you can buy back the call for intrinsic value and still have a profit.
rwbil — You are correct in your characterization of what I did.
Here is my thinking behind the trade:
Why long EWJ:
Over the medium term, as in after the fed stops raising rates (and the U.S. is in a recession), the dollar is going to go down. Combine that with a recovery in Japan, and you have an ideal combination for a rise in the dollar value of Japanese stocks.
Of course, people disagree over whether the yen is going to go up vs. the dollar. Some say it can’t because the rise in interest rates and exchange rates will kill Japan’s recovery, like it did the last time they tried to end ZIRP. Others (specifically Stratfor) say the dollar will go down vs. the yen because Japanese pension funds repatriating investment money into a recovering Japanese economy with greater investment opportunities (including positive interest rates!) will end the carry trade. But in either case, Japan seems to be recovering and its stock market going up, and, though I am late to the party, there at least is still a party going on.
Of course, the biggest risk of all to this is that it is already priced in, since everyone from Bill Gross on down knows about it, as evidenced by the fact the Japan CEFs are all trading at a premium.
Why the covered call writing:
Here, I am playing the odds. The odds are that the Japanese market is not going to go up a whole lot right away, since it tends to follow the U.S. market over the short run. Also, the dollar will not go down as long as the fed is raising rates, which is to say, through at least May. (6% by the end of ’06 is still lookin’ good to me.) The currency turn, if it comes at all, will probably come after the fed stops raising. So, while I don’t expect the Japan market to go down, I don’t expect it to go up, and I see a short-term opportunity to make some money off of the greed of others. As I see it, the worst that will happen is that the shares will get called away at a small profit to me, an outcome to which I am indifferent. WTF, it’s only an ETF — It’s not like I’m in love with it.
And, buying EWJ is an intermediate-term trade, not a long term investment. I do not know of anyone who is bullish on Japan over the long-term. (Even Stratfor expects the country eventually to implode from all the debt.) We’ll revisit it in a year or so to see where things stand.
Finally, having been hosed more than a few times, I can say Barry is right — covered call writing does have its risks. But it also saved my a– on a number of trades during and after the tech bubble, as a result of which I only lost my shirt, as opposed to my life savings. (Premiums on tech stock calls were a lot higher in those days.)
Again, I am not recommending this — only putting it out for comment, which you have graciously done.
Any comments about my underlying assumptions would be appreciated as would any ideas about how to invest in the Japanese defense sector. That I think might be a good long term investment. (Again, not a recommendation, just an idea.)
GRL,
What’s the strike on your calls? I didn’t see that anywhere.
Also, I am bullish on Japan in the long term (not so much short term after the huge run of the last few years), so now you can’t say NO ONE is long term bullish on Japan. Personally, I don’t think their debt will cause them to implode, due to their high savings rate and the fact that they owe the money to themselves.
May 19, 2006 15 calls — symbol EWJEO
Tough to be bullish on a country facing a 30% decline in GDP based on working population decline alone. Unless they can reform their immigration policy, they’ll be sinking all their money into nursing home fees come 15 years from now.
Malaysia and Taiwan can be purchased thru iShares: EWM, and EWT respectively.
They trade in the US (no currency risk) and are quite liquid — 1 to 3 million shares per day
No currency risk? They may be priced in dollars but surely the underlying stocks are priced in the local currency. If it falls surely the dollar value of the ETF falls.
Hey Barry,
I would love to hear your thoughts on this unabated “sea-of-liquidity” environment.
It was interesting to note that GOOG’s Jan top came within a week or so of that analyst’s $2,000 prediction that was more of a stunt than an official call.
On a similar note, in mid-March I thought perhaps Goldman’s blow-the-doors-off earnings announcement might have been the tolling bell for the liquidity boom… A big bang, final frenzy type of thing, what with America, Europe and Japan all tightening at the same time and China getting antsy over USTs.
Consumer staples and other ‘stodgy stocks’ were moving higher at the time (mid-March) too, confirming a potential flight to quality that guys like Grantham have been talking about.
Then Gentle Ben stomped on the one-and-done meme, openly stated that the Fed was eyeballing sky high commodity prices… and all the liquidity-driven sectors went through the roof anyway, while stodgy stocks got dumped. Say what?
I mentioned on another thread here how crazy the April 3rd action was–it seems like every single emerging market ETF that mattered broke out big to the upside. Then on April 5th, just to make things weirder, you have the Philly Housing Index breaking out like a champ.
Again, say what?
It’s as if the markets were giving Bernanke a big, giant raspberry. Maybe they think he’s all talk and no walk. Or maybe there’s just an air of eat, drink and be merry, ’cause tomorrow the taps go dry.
I got long on emerging market equities like everyone else after that massive April 3rd breakout. If the liquidity wave is going to keep on rolling, traders gotta keep on surfing… but I can’t help but wonder what the hell is going on.
when I look at the daily charts of EWM and EWT all I see is a giant near-term sell signal. what am I doing wrong fellas? as for cramer, always my favorite character on Seinfeld. who’d a thunk he would turn out to be a stock savant as well. amazing world.
Barry, it is a friday after a strong week in technology. Fridays tend to move opposite the weekly trend. What’s going to be interesting is that earning season starts next wednesday in full force. I lightened up quite a bit on thursday and am (rationalizing) somewhat of a consolidation of the recent gains.
trader75-
well said! a lot of things don’t really make sense right now. As the 10-year hit a 4.99% yield this afternoon, homebuilders rallied. Didn’t make sense to me. But then again, why does oil continue to rally even on huge inventory levels?
Once money starts floating around from place to place with no clear direction or purpose I think we become at increased risk for a major correction. The best way to clear out some of the money supply is with a correction. If the Fed starts to believe inflation is getting out of hand… watch out.
BTW, anyone else see this article this afternoon?
Fed’s Poole says inflation spike is hard to reverse
WASHINGTON (Reuters) – It would be harder for the
Federal Reserve to deal with a spike in inflation than a softening of growth, a key Fed policy-maker said on Friday, suggesting the central bank may want to err on the side of higher interest rates.
http://news.yahoo.com/s/nm/20060407/bs_nm/economy_fed_poole_dc
And how’s this for inflation…
FedEx Freight announced Friday it will raise general service rates by 5.95 percent beginning on April 24.
>>>>6% is a BIG number.
A quote by Poole from the article linked by todd:
“As long as the inflation rate stays where it is, there is no reason not to have the economy continue to grow,” he said.
And, as long as Elephants have wings, they can fly.
Along the same lines, here is an interesting discussion about the “sacrifice ratio” from a while back quoting Donald Kohn:
” ‘……the sacrifice ratio rose from around 2 or 3 in the mid-1980s to around 4 currently. Imbalances between demand and potential supply would thus now be slow to show through convincingly to inflation, but when they do, they may be costly to correct.’
“Here is Chairman designate and then Fed Governor Bernanke’s SR reference in a 2003 speech. Bernanke said: ‘Now make the assumption that the sacrifice ratio is 4.0, a high value by historical standards but one in the range of many current estimates.’
“What does a rising SR mean for interest rates?
“It means the Fed is likely to persist hiking rates higher and longer than the market expects. . . .
http://www.2000wave.com/article.asp?id=mwo011306
For those of you who aren’t Kohnheads, in plain English that translates to 6% by the end of ’06.
(IMHO)