Tag Archives: russell 2k

Commercial Traders Own the Stock Market’s Gyrations

The stock market doesn’t seem to know whether good news is good or bad news is good. The equity markets have sold off between 4 and 6 percent since we published this key reversal in early March with the small cap Russell 2000 and Nasdaq 100 tech stocks peaking a month before the big Dow and S&P stocks rolled over. April’s unemployment report supplied the catalyst for the Dow and S&P sell off but again the question becomes, “is bad news still good for business friendly easy monetary policies or, does good news mean we’re finally back on track?” Based on a number of factors, it appears the answer is somewhere in the middle. The Goldilocks equity market likes its data neither too hot nor, too cold.

Continue reading Commercial Traders Own the Stock Market’s Gyrations

Trading’s Gut Check

Actively participating in the markets comes with the understanding that the trader’s gut will be checked frequently and deeply. The primary cause of this is the trader’s degree of certainty in an uncertain world. It’s been proven over and over again that once an individual feels that they have enough information to make a decision, they will. Additional information provided after the fact typically raises the degree of certainty that the correct decision was made, rather than raising the degree of accuracy. So, I sit in front of the Federal Reserve Board’s announcement this afternoon involved up to my eyeballs in the US Dollar, Euro currency, 10-year Treasury Notes and the Russell 2000 stock index.

Each one of these positions is the result of mechanical trading programs that I’ve developed, tested and traded. Therefore, there are no arbitrary decisions or adjustments to be made. This leaves me in front of the screens sitting on pins and needles waiting for a range of possibilities to materialize. Given my experience with the markets, I expect the outcome to be somewhere in the middle. Rarely does it turn out one sided either positively or, negatively.

Let’s review the possible outcomes and the gut wrenching turmoil that comes with sitting on several large positions as I try to close out the books for 2013. My oldest position on the books is short the Euro FX. I stand to profit if the Euro currency weakens against the US Dollar. I’m short the market near the top of its range based on my research into the Commitment of Traders Reports. I know that there’s about a 60% chance the Euro will back off these highs by about a penny and a half. However, the market’s continuing consolidation near these highs puts me in a position where I could be stopped out of the market with a loss even before the Fed announces its decision this afternoon. The market’s proximity to my stop loss order contributes greatly to my angst.

The opposing position to the Euro is my long US Dollar Index position. Again, I’m long the US Dollar Index against a basket of currencies, which is dominated by the Euro. If the Fed suggests that they will begin to taper quickly, the Dollar should rally. Pulling stimulus out of the economy will place fewer Dollars in future circulation thus, increasing the value of the Dollars already in the market. The Dollar would rally and the Euro would fall. Both of my currency positions would be profitable.

Tapering by the Fed would most likely crush my 10-year Note position. Frankly, the discretionary trader in me can create the strongest case for owning 10-year Notes and betting against taper talk. Based on my analysis of the commercial traders in the 10-year Note I fully expect any decline in Treasury prices to be short lived. Commercial traders have accumulated their largest net long position in the 10-year Note since April of 2005. Commercial traders have dominated the big moves in the Treasuries with uncanny accuracy. If they’re right about no taper talk this afternoon, Treasuries will rally substantially and I’ll profit from my position….while losing on my currency trades.

This leads to my final position. I use a pretty fancy program for developing my day trading systems. Whereas my swing-trading program is based on the fundamental data inferred from the collective positions of the markets’ participants, my day trading programs are strictly technical. Knowing that the markets will unfailingly put a man to the test, it should come as no surprise that my day trading programs now have me long two units of the Russell 2000 stock index heading into this afternoon’s announcement. Furthermore, while I have some expectations of how the currencies and Treasuries will react to the Fed’s decision, the stock market’s reaction is far less predictable. If the Fed tapers, the stock market may rally further based on the assumption of a strong economy leading to further gains. However, the collective reaction could very well be violently lower as tapering could signal the end of the free money that many believe has fueled the rally to this point.

Discretionary traders face conflicting data like this all of the time and pick and choose which markets they’re in and when they’re in them. Systematic traders follow the signals generated by their programs without question. The cruelest aspect of trading is the market’s uncanny ability to seek out a traders’ weak spot and twist agony’s knife. I’ve been actively trading for more than 20 years and the trepidation of a pending report never goes away. This is where the classic line, “Plan your trade. Trade your plan” has the most value. Remember, additional information acquired after the fact doesn’t increase the odds of being right, it simply tricks the mind into greater certainty of the existing thought pattern.

Equity Market’s Race to the Top

The equity markets have just been rip roaring strong. Companies like FedEx, Google, Morgan Stanley, Walt Disney and Boeing have all gained more than 40% this year. The equity markets have made new all time highs, eclipsing the pre-crash highs from 2007 with hardly a shudder and soldiering on past the tech bubble highs of 2000. Recently, the technical analysts at Merrill Lynch came up with a four-year target of 2300 in the S&P 500. This is based on their analysis of the long-term pattern that was triggered by the new highs. The S&P 500 has climbed more than 150% since March of 2009. While I’m the first to admit that I’ve left a lot of money on the table by not sticking with the long side of equities, I’ve been doing this long enough to know that there’s always another trade. Therefore, I will not be committing new money to the long side of the equity market at these levels in 2014.

The way I see it, there are two opposing forces at work here. First, we have the Federal Reserve Board that keeps pumping money into our economy. The Fed continues its easy money policies indefinitely. There are seven voting members of the Federal Reserve Board of Governors. Six of them have been broadly categorized as dovish, in favor of easy money/stimulus. There are four more rotating members from the national Federal Reserve Banks. This is where things may get a bit interesting. Three of the rotating members gaining a vote in 2014 are centrist to hawkish. While the doves are still clearly in control, especially with Janet Yellen expected to assume the Presidency of the Board, the dialogue in the minutes of their meetings could change substantially.

The easy money policies have favored the equity markets in a couple of different ways. The artificially depressed interest rates have forced investors to accept more risk for returns that used to be outside the scope of retiree investing. The stretch for yield has driven a boom in riskier corporate bonds as investors move down the ladder in an attempt to maintain their portfolio’s value. This has caused a surge in lower credit bond prices reminiscent of the sub prime mortgage debacle of the mid 2000’s.  Investors’ lack of satisfaction with the governmentally manipulated yield curve has led them to seek returns in the stock market specifically, through high yield investments like Real Estate Investment Trusts and utilities. What has gone unnoticed is the disappearance of nearly half of the companies listed on U.S. exchanges. Therefore, there’s more money than ever chasing a smaller number of stocks in the last 25 years.

Secondly, we have reached valuations that bode poorly for long term investing. Research abounds on the usefulness of long-term valuation models. Very simply, expecting these returns to continue through long-term investment at these valuations would set an historical precedence. Anything can happen in the world of markets but the odds clearly show that bull markets do not begin when the P/E ratio of the S&P 500 is above 15.  The S&P 500’s P/E ratio currently stands above 19 and Nobel Prize winning Yale economist Robert Schiller’s cyclically adjusted price earnings (CAPE) ratio is over 25. Both of these will continue higher as long as the equity markets continue to climb. Neither is sounding the, “Everyone to cash,” alarm bell. Their history simply suggests that it would be foolish to expect these multiples to continue to climb and climbing P/E ratios are necessary for stock market growth.

Closing in on 2014 has left many money managers whose performance is benchmarked against index averages scrambling to catch up. There are two ways a manager can do this. First, wait for a sell off and try to buy in at a discount. This is part of the reason that the weakness in July, August and October was so quickly recovered. Second, apply leverage so that the manager’s fund gains more than $1 for every $1 the market moves. Leverage seems to be the move of choice. This year has seen a huge inflow into equity mutual funds, which have to be benchmarked to their index. By comparison, each of the last two years saw net equity mutual fund outflows. The added influx of cash has led investment managers into the futures markets, specifically the S&P 500 futures. The most recent Commodity Futures Trading Commission’s Commitment of Traders report shows a 10% growth in leveraged longs as well as a 5% decline in leveraged shorts. Finally, margin debt on the stock exchange itself has also reached an all time high.

The case I’ve laid out says nothing about where we’re going. Liken this presentation to a new home survey. The place has curb appeal. The neighborhood is growing. The government is supporting its growth. Each new home sells for more than the last. What could be wrong with buying now? Well, the inspector may inform you that everything you believe to be true is resting on a shaky foundation. The house may stand for years or, not. Personally, I’d rather be in on the ground floor than looking for a window to jump out of having climbed in at the top.

Insidious Effects of the Dollar’s Decline

The United States is home to the largest and most liquid investment markets in the world. There’s hardly a market one can think of that isn’t exchange listed. This has made the United States the primary destination for excess global capital placement whether it has gone towards the relative safety of government bonds or been more aggressively allocated towards stocks, ETF’s or even the futures markets. The final destination of the investible funds is less important than the singular characteristic that all these investments have in common. They’re denominated in US Dollars and the Dollar’s value may be more meaningful than the underlying asset class.

Investment securities are not protected from the vagaries of their underlying currencies. Therefore, globally allocated investments owned in US Dollars can lose money in a flat market if the Dollar declines. The Dollar peaked in early July and has since fallen by more than 6%. Therefore, if your US equity portfolio hasn’t gained more than 6% since July, you’ve actually lost money. The Governmental shut down has accelerated the recent slide and pushed the Dollar to a new 30 day low for the second time this week. This is only the second time since May of 2011 that we’ve made multiple 30-day lows in the same trading week.

Perhaps more troubling to global investors than the currency-based loss is the fact that the traditional safe haven investments, even in Dollar terms, have not behaved as expected. The primary relationship between the Dollar and the US equity markets since the financial implosion of 2008 has been negative. This has been embodied by Dollar rallies on stock market declines. Very simply, foreign capital gets converted to US Dollars and placed to work through buying declines in the stock market. Conversely, when foreign investors take profits in a rising stock market and convert back to their base currency, the Dollar falls.

We also see this relationship play out in the gold market. Economists on TV tell us to buy gold as a defense against a declining US Dollar. Sensationalists point to the overwhelming debt being created by our country and tell us to buy gold because our country is on the verge of implosion and our currency will become worthless. Speaking of correlations, it’s amazing how many of the people saying this are the ones selling gold investments. Astute investors would notice that the correlation between these two markets has been trending upwards since early June. This means they’re moving in the same direction more frequently rather than opposite each other as expected.

Foreign purchases of US goods have always been Dollar dependent. Every nation and agricultural enterprise within every nation is forced to tie their commodity purchases accordingly. Therefore, it becomes especially disturbing when a weaker Dollar fails to attract foreign purchases of global staples. Beginning in August of 2012 we started to see the commodity markets decouple from the US Dollar. Wheat was the first market to be sated. Corn followed suit in October of 2012 and hogs joined the new normal last November. This means that even base foreign needs have been filled. Therefore, they are more likely to trade in the same direction as the Dollar going forward rather than the typical negative correlation that we’ve seen from bargain hunters looking for inflation in the commodity markets.

The International Monetary Fund (IMF) stated that world Consumer Price Index (CPI) came in at 3.2% year over year for August. This is down from 4.9% a little over a year ago and ties in rather neatly with gold’s last run at $1,800 per ounce early last October. The US unemployment rate is generally believed to be artificially low in the as reported number of 7.3% and Gross Domestic Product (GDP) here in the US came in at a very tame 2.5%. These statistics, combined with a low global industrial capacity usage number suggest that inflation is nowhere near. Furthermore, the Federal Reserve Board’s recent decision not to implement a tapering of the $85 billion per month in economic stimulus reinforces the notion that their primary concern is deflation, rather than inflation.

Many economists believe that we may be near a tipping point in the bull run that has followed the economic meltdown of 2008. The obvious concern now lies in the protection of the wealth that’s been garnered during the recent run. Clearly, the ownership of alternative investments isn’t going to play out the way the pundits have suggested. Therefore, investment vehicles that will profit from a decline in both asset value and currency depreciation should be seriously considered. These include inverse ETF’s as well the futures markets, which will allow the seamless execution of short trades including currencies. Equity futures spreads selling small caps like the Russell 2000 and buying big caps like the S&P500 are also a good idea when expecting volatile, downward markets. Remember that cash is only king as long as the King’s throne isn’t sinking.

Planning Ahead Trading Futures

They say that the most important read for a comedian is timing. The comedy in trading is that the market typically delivers its own punch line at the expense of the trader’s timing. Twenty years of trading has proven one thing right over and over again; traders aren’t meant to get it right. The markets constantly change and a pattern that has been developing for months may be no good on the day the trader pulls the trigger. When the trader is right, they’re lucky to price either the entry or the exit well. Typically, there’s meat left on both sides of that bone. Therefore, the psychological positive reinforcement must come from the bottom line, rather than the lines on the charts. With this in mind, let’s look at some trading opportunities on the horizon and how to prepare for them.

Starting with a seasonal top, unleaded gas should be rapidly approaching its seasonal high. The build in prices tends to peak just past Memorial Day. Whether this is a gasoline producer conspiracy or, purely supply and demand, there’s no argument about when it hurts the most. The unleaded gasoline market has put in a very tradeable top in eight out of the last 10 years during the Memorial Day – June 15 window of opportunity.

Moving to agricultural commodities takes us to the typical weather patterns and their effects on crops. It’s important to understand that the historical seasonal patterns are based on the most probable outcome of a full data set. Therefore, extreme weather events like drought and flood will only register as one year’s data. Thus the historic spikes we’ve seen don’t have nearly the impact when compared to 10 or 20 year’s worth of data. This is why sample size is so important when providing the general guidelines for what’s expected to happen.

Once we get past Memorial Day, we’ll begin looking for a bottom in the live cattle market before June 10th. Fundamentally, the cattle market should be well supported. There simply aren’t many cattle out there. The breeding herd has been on a gradual decline for years. This year is no exception with the 2013 herd coming at the lowest level in 61 years. The tiny herd size provides the market with two different ways to rally. First of all, if corn prices remain low, we’ll see cattle affordably held back for breeding. Secondly, if corn prices rise, we’ll see the herd size continue to dwindle. Either scenario takes steaks off the summer grill.

Fortunately, you’ll be able to finance that new grill using the falling interest rates that typically begin between Memorial Day and the third week of June. Even though some of the newer interest rate contracts may not have the history of cattle, corn or, gold at least interest rate futures all tend to trend in the same direction. The typical pattern is for interest rates peak in the early summer and decline through the rest of the year and into lay-away season.

The final classic summer seasonal trade is to sell soybeans once the planting fears have begun to pass. The soybean market always has support through the planting season. In fact it’s not uncommon for soybean futures to set their high price for the year in May or June. Once the crop is safely in the ground, the market breathes a collective sigh of relief. Given normal growing conditions, the decline in prices really picks up after pollination in July.

The summer markets appear to have gotten off to predictable starts. I think the one, notable exception is the strength in the stock market, which we believe has about run its course. In fact the Russell 2000 – S&P 500 spread trade we mentioned last week appears to have finally turned in our expected direction. The most important concept in these trades is being aware of the seasonal tendencies of different markets as they approach. Mark them down on your calendar. It will take half an hour to do the entire year’s worth for the markets you actually trade. This way you’ll always know if you’re near a market’s inflection point and in trading, predicting inflection points is how we measure our timing.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Spread Trading the Russell 2000 Vs. S&P 500

The stock market has made a lot of noise this week with the Dow Jones Industrial Average climbing above 15,000 for the first time in history. In fact, all of the major averages are up about 18% year to date. There is a general consensus that the massive liquidity operations the Federal Reserve board has implemented are the primary contributor to the market’s rally. However, there are several competing theories as to where the top may be. This week, we’re going to take a look at seasonal tops in the Russell 2000 small cap stock index compared to the S&P 500 large cap index to try and lock in some profits while minimizing downside risk.

The Russell 2000 is a stock index made up of small companies with a median market capitalization value of around half a billion dollars. This compares to the S&P 500 market capitalization average of nearly 28 billion dollars. Another way of putting this in perspective is that the Russell 2000’s largest company by market cap is Alaska Air as compared to the S&P 500’s largest company, Apple. The important thing here is to differentiate the small cap growth stocks of the Russell 2000 from the large caps that make up the S&P 500.

The reason for this is that small caps and large caps tend to behave differently. Small caps tend to lead. Therefore, they overshoot the tops and the bottoms. The smaller nature of the stocks in the Russell 2000 means that it takes less money to move the underlying stock. Small companies are also easier to grow. Of course, extra growth comes with extra risk. The composition of the Russell 2000 changes regularly due to new companies being added while others are removed. The large cap indexes like the S&P 500 are more stable due to the massive size of the companies it’s comprised of. Steady, stable, predictable growth is what is hoped for in the S&P 500.

We’ve all heard the old adage, “Sell in May and walk away.” There is a bit of truth to this as the primary stock market gauges are typically flat through the summer with a bit of upside bias and lots of downside volatility. In fact, this seasonality is even more pronounced in the Russell 2000, which tends to bottom in August. In other words, growth is minimal while full risk exposure remains. This is not an ideal risk to reward scenario. Over the last ten years, the Russell 2000 has called the late spring / early summer top correctly eight times. The two years it was wrong were 2008 and 2009 when the markets had already been beaten down. The average profit on the trade I’m about to detail was $4,250 for the other eight years.

There are two different ways to lay this trade out. The complicated way would be to find the least common multiple of the underlying futures contracts and work out the rest of the equation as percentages and then translate the percentages back into dollars and cents. Fortunately, we can simply use the futures contracts as they are and buy an S&P 500 futures contract while simultaneously selling a Russell 2000 futures contract.

This application takes advantage of the Russell 2000’s larger built in multiplier. Calculating the value of the Russell 2000 futures contract is as simple as multiplying the index by its $100 multiplier. Thus, a June mini-Russell 2000 contract trading at 970.00 has a cash value of 970.00 X $100 = $97,000. Meanwhile, the mini-S&P 500 has a built in $50 multiplier. Therefore, the mini-S&P 500 futures contract has a cash value of 1625.00 X $50 = $81,250. Buying one mini-S&P 500 futures contract and selling one mini-Russell 2000 creates a net short cash value of  $15,750 worth of small cap stocks.

The maximum value for this spread position was $16,671 in May of 2011. This represents the farthest the Russell 2000 futures have climbed above the S&P 500. We recently made a high of $16,200 two weeks ago.  Currently, this spread is trading at $15,350. I expect the recent April high to hold. If the market trades above the recent high of  $16,200, I will exit the trade at a loss. Recently, the average price for this spread is around $11,500. Therefore, I will use this support as the first place to look for profits. This sets up a trade that is slightly short the stock market through exploiting seasonal and market capitalization biases. Furthermore, this trade has had a relatively high historical winning percentage and is currently providing us with a 4-1 risk to reward ratio.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

The AP Hack Crash Facts

The first article of mine that was picked up by the Sandusky Register was written in the late afternoon on May 6th, 2010 as I put together the notes for our clients explaining the “Flash Crash,” what and how it had happened. Tuesday afternoon the Twitter account of the Associated Press was hacked and the following tweet was sent from their account, “Breaking: Two Explosions in the White House and Barack Obama is injured.” The stock market plunged one percent in less than three minutes. Within five minutes, it had returned to its previous level. Let’s take a look at some of the issues this brings to the trading table.

The market is always the boss. Traders at their desks can employ a thousand models suggesting the market should move in a certain direction. However, anyone sitting at a trading desk or on the trading floors will tell you, when you’re in the market, you’re playing the market’s game on the market’s terms. Therefore, when prices move rapidly and unexpectedly against a trader’s position self-preservation kicks in and the trader exits the position – THEN searches for the catalyst that suddenly turned the market against them. Rule number one in trading is self-preservation.

This mentality is best evidenced by protective stop loss orders that automatically trigger when a market moves beyond the trader’s loss threshold. Meanwhile, another group of traders prefers to exercise their own orders in which case, they’ll manually enter their order as the market exceeds their pain tolerance. These two groups were the ones hit with losses as they raced each other to the bottom in an attempt to unload their positions. For the record, our protective sell stops were also hit on the way down. Think of it as a bank run. There’s always enough cash to cover the withdrawals of those at the front of the line.

The traders most deeply affected by the sudden downdraft and ensuing return to normalcy were the day traders and the high frequency traders. Our position in the Russell 2000 stock index yesterday was a day trade on the long side of the market based on follow through from Monday’s outside day. Monday’s outside day is defined by falling through Friday’s low only to turn around and close above Friday’s high. This is a very bullish signal when coming at the extreme of a recent move. This outside bar combined with some other analysis put us on the long side. Protective stops had been placed and adjusted throughout the trade leading to a small win. In this case, not placing a protective stop would’ve been much more profitable but, what if the Associated Press had been right?

Once the market began to sell off, high frequency traders joined in the game. High frequency trading is day trading without the human input. Humans write the computer programs and the programs being fed the live data stream automatically executes the trades at the exchange. These programs have replaced the scalpers you’re used to seeing on TV in the trading pits yelling at each other. High frequency trading gets a bad rap for increasing market volatility but gets no credit for providing market liquidity. Liquidity is THE most important aspect of U.S. financial markets. Liquidity is why we are the global financial capital. Without liquidity there is no one to take the other side of the trade. Without liquidity there is no market.

Finally, let’s put it all together. The market was quietly trading up about half a percent on light volume when the AP’s tweet was posted. Volume exploded by a factor of 10 as the market declined. The volume surge that was taking day traders and tightly placed protective stops out of the market was being replaced by high frequency trading programs that are ALWAYS called to action by volatility and volume. Ironically, the same high frequency trades that made a killing during the flash crash actually got burnt by the, “Hack Crash” as the market returned to normal faster than newly initiated short positions could be covered at a profit.

There is little predictive value in the events of the, “Hack Crash.” However, there are some key takeaways for traders. First is the importance of protective stops. One never knows what could happen next. Second, verify news reports. I have the AP’s iPhone app, which alerts me to breaking news and had no mention of the tweet until after the fact. Therefore, the corporate disconnect between Twitter and their app was my first clue it was bogus. Finally, cut the high frequency traders some slack. Their programs are based on risk and reward just like our own and the liquidity they provide in times of dramatic events is exactly what allows us to get out of the market and keep some powder dry until the smoke clears.

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk of loss in investing in futures.

Commercial Trader’s Role in the Stock Index Futures

This blog is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. The blog is meant for educational purposes and to develop a dialogue among those with an interest in the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures.

The stock market’s recent sell off between 7.5% and 14% depending on the index, was immediately followed by five straight day’s worth of rally. Apparently, the TV pundits are saying that the electronic meltdown was just what the market needed to attract fresh buying to the markets and push them back to 2007’s happy market levels. Unfortunately, based on commercial traders’ positions, they don’t seem to share the talking heads rosy outlook. In fact, their trading actions appear to favor, “The Coming Double Dip,” opinion.

Throughout the month of April, commercial traders have been steadily building short positions in the stock index futures. The behavior of the institutional trader is to vary their short position in the stock indexes to offset their perceived sense of risk in the stock positions they currently own in their portfolios. The execution of short hedges in the stock index futures allows them to hold on to their individual issues. The ability to protect their portfolio without having to sell individual issues also protects them from incurring capital gains penalties on their core positions. Thus by tracking commercial traders’ momentum we can get a feel for not only their positive or, negative outlook on the stock market but also their sense of urgency.

Individual investors need to know what options are out there to help them protect their hard earned equity portfolios. The stock index futures offer direct hedges to the Nasdaq, Dow, S&P 500 and Russell 2000 indexes. These markets cover everything from blue chips to heavy tech and small cap. They also trade in various size contracts to help tailor hedge positions to your underlying investments.At these levels, the small contracts have approximately the following cash values:

Market                 Cash Value        Margin RequirementS&P 500                      $56,500                  $5,625Dow Jones                  $52,500                  $6,500Nasdaq                        $18,750                   $3,500Russell 2000                $68,000                  $5,250

Using the above values, one can see the effectiveness of using futures to hedge an equity position, rather than a Contra, Profund or, other inverse equity mutual fund through the following example.

John Doe has $250,000 in equity positions through individual stocks, mutual funds and retirement plans. John is afraid that the market’s rally has run its course and given the overall economic outlook, would like to be able to protect his portfolio in the event of a downturn. Unfortunately, John has had some of the individual stocks for so long that his cost basis makes selling them and paying capital gains taxes an unappealing option. Several of his mutual funds are held in various retirement accounts run by managers who don’t solicit investment advice from their clients on a regular basis. Finally, John has another $75,000 in cash, short term rates and money markets. He considers this his operating cash for any opportunities or emergencies that might come up. So, what can John do protect his self in the event of a market downturn without tying up all of his free cash?

Assuming he would like to hedge half of his portfolio, he would determine the makeup of his holdings to see how he’d like to balance his hedge – small cap, blue chip, tech, etc. Now, he wants to give himself room for another 10% higher in the equities due to the “January Effect” or, market exuberance. Therefore, the free cash needed for this strategy would be approximately, $16,000 in margin to carry the equivalent of a $125,000 short equity mutual fund. Plus, he’s going to need an extra $12,500 to provide a cushion of another 10% rally in the equities. His total free cash outlay is $28,500. Thus, he effectively hedges half of his equity position while tying up only 25% of his operating cash.

The commitment of traders report for the stock indexes can be a good barometer for anticipated movement in the stock market. Furthermore, through the use of stock index futures and a competent broker, individuals can implement the same type of equity protection as the big boys.

Please call with any questions.Andy Waldock866-990-0777

Volatility’s Perfect Storm

Volatility’s Perfect Storm

I’ve been actively trading the stock indices – S&P 500, Nasdaq, Russell 2000 and Dow futures for 20 years and I’ve never seen a day like today. It was truly a, “Perfect Storm.” I believe this will happen more and more frequently in the future as the three main reasons for May 6th’s volatility are gaining momentum all of the time.

First, public complacency was the highest it has been since the summer of 2007. Every bailout and new government program bolsters the warm and fuzzy investor psyche that allows us to believe everything will work out. The Volatility index measures the cost of protecting your stock portfolio through the purchase of put options. Put options are like buying portfolio insurance. If you hedged your $300,000 stock portfolio it would have cost you approximately $8,500 in put premium to protect the full value of that portfolio through June, from any downside risk. That same insurance policy in the afternoon would have been worth $23,625. Considering the value of your portfolio equaled the decline of the stock market, you would’ve lost 3.25% on your $300,000 or, $9,750. The difference between the $8,500 paid up front versus the current portfolio’s value of $290,250 plus the current value of the insurance policy $23,625 means that your net worth on the stock market’s biggest point loss day in history would have actually INCREASED by $5,375. The increase in the VIX is the reason for the inflated option premium and the magnitude of the rally of the VIX bears testament to the market’s general complacency.

Secondly, All of the markets are tied to each other. That’s why we are Commodity AND Derivative Advisors. In the age of electronic commodity trading, one issue always affects another one and that one in turn, affects another on and so on. Every trade in an outright market like the S&P 500, Euro Currency or, Japanese Yen will have an effect on the other markets related to it. This has, in effect, created one giant butterfly effect. In the age of algorithmic trading, where the minutest of market inefficiencies are exploited by aggressive capital placement, abnormal market moves will become self fueling. Many of these models use markers based on the model’s expectation of, “normal,” relationships to its data points. When things get pushed beyond the model’s, “normal,” expectations you have a case of, “If you liked stock ABC at $12 a share, you’re going to love it at $4 a share.” There were at least two stocks in the S&P 500 that traded to 0, today. This means they were broke, bankrupt, didn’t exist. Two Fortune 500 companies disappeared on someone’s lunch break and by the time the employee got home from work, no one knew the difference. Twenty minutes of electronic market butterfly effect.

Finally, as the market began to fall, the media was showing the Greek police force in full riot gear after passing their severe austerity vote in an attempt to procure financing from the European Union. Furthermore, the context of the day’s discussion among the talking head TV pundits was the doom and gloom surrounding the demise of the European Union, civil protest and bankruptcy in Greece with the specter of Spain’s impending default as a backdrop. Doom and Gloom sells. Traders, both retail and institutional are listening to the end of the world as we know it while watching the stock market meltdown and trading programs are ticking off one sell order after another in an attempt to be the first ones to market with their orders. The pursuit of greater bandwidth on their data feeds, faster processors in their computers and deeper levels of quantifiable algorithms put them in the lead in the race to the bottom and right back up. Welcome to the new age of 24 hour doom and gloom media coverage, total connectivity and computer programs replacing common sense trading. We specialize in common sense trading.

 

This methodology is published by Andy Waldock. Andy Waldock is a trader, analyst, broker and asset manager. Therefore, Andy Waldock may have positions for himself, his family, or, his clients in any market discussed. This method is meant for educational purposes and to illustrate the correlation between the commercial’s trading and its effect on creating turning points within the commodity markets. The commodity markets employ a high degree of leverage and may not be suitable for all investors. There is substantial risk in investing in futures. The information contained herein comes from sources believed to be reliable, but are not guaranteed as to accuracy or, completeness.

 

Protecting Your Equities with Futures in the Current Political Environment

Barney Franks is attempting to make shorting stocks all but impossible. Individual investors need to know what options are out there to help them protect their hard earned equity portfolios. The stock index futures offer direct hedges to the Nasdaq, Dow, S&P 500 and Russell 2000 indexes. Furthermore, the CFTC tracks positions in these markets through the Commitment of Traders Reports which help put us on the same side as commercial traders. These markets cover everything from blue chips to heavy tech and small cap. They also trade in various size contracts to help tailor hedge positions to your underlying investments.At these levels, the small contracts have approximately the following cash values:

Market                 Cash Value        Margin RequirementS&P 500             $56,500                  $5,625Dow Jones        $52,500                  $6,500Nasdaq             $18,750                   $3,500Russell 2000    $63,500                  $5,250

Using the above values, one can see the effectiveness of using futures to hedge an equity position, rather than a Contra, Profund or, other inverse equity mutual fund through the following example.

John Doe has $250,000 in equity positions through individual stocks, mutual funds and retirement plans. John is afraid that the market’s rally has run its course and given the overall economic outlook, would like to be able to protect himself in the event of a downturn. Unfortunately, John has had some of the individual stocks for so long that his basis makes selling them and paying taxes an unappealing option. Several of his mutual funds are held in various retirement accounts run by managers who don’t solicit investment advice from their clients on a regular basis. Finally, John has another $75,000 in cash, short term rates and money markets. He considers this his operating cash for any opportunities or emergencies that might come up. So, what can John do protect his self in the event of a market downturn without tying up all of his free cash?

Assuming he would like to hedge half of his portfolio, he would determine the makeup of his holdings to see how he’d like to balance his hedge – small cap, blue chip, tech, etc. Now, he wants to give himself room for another 10% higher in the equities due to the “January Effect” or, market exuberance. Therefore, the free cash needed for this strategy would be approximately, $16,000 in margin to carry the equivalent of a $125,000 short equity mutual fund. Plus, he’s going to need an extra $12,500 to provide a cushion of another 10% rally in the equities. His total free cash outlay is $28,500. Thus, he effectively hedges half of his equity position while tying up only 25% of his operating cash.

As the Barney Franks have their way with allocating investor opportunity, it will become ever more important for the individual investor to know what his options are and how to use them.Please call with any questions.Andy Waldock866-990-0777

In Order To Make The Ponzi Market Keep Going Ever Higher, Barney Frank Tries To Make Shorting Virtually Impossible Submitted by Tyler Durden on 01/06/2010 14:01 -0500

As part of the Barney Frank proposed Manager’s Amendment, which will accompany HR4173, the “Wall Street Reform and Consumer Protection Act of 2009”, are three little-noticed rules that, if adopted, will make shorting stocks if not impossible, then extremely problematic and difficult. It is obvious why these rules would end up in an amendment: the outcry from retail and institutional traders would have been huge had these proposals made the full text of the proper Bill, and into the full view of the Mainstream Media. So why bother with these – simple. As everyone is aware, Ponzi schemes only work when constantly growing, as otherwise they blow up, implode under their own weight, once price discovery is attempted by all. Case in point: when Madoff’s securities was unable to find another greater fool in the face of collapsing asset values, the jig was up overnight, and the value of the pyramid went from $50+ billion to $0 instantaneously. In this manner, Ponzies are like sharks – they need to swim to live: any deviation from the norm threatens their very survival. By comparison, shorting has always been the most traditional way to force price discovery: as idiot money pension funds tend to be long-only, selling only occurs in times when book gains have to be realized, and facilitates a rising market without any natural checks and balances. If this amendment passes, the entire equity market will have become Madoff securities to the dot. It will continue going up, until market values are a reflection of no underlying fundamentals, but simply the latest pension fund long-only dumb terminal willing to throw managed capital into the bonfire of an inevitable future stock market collapse. And, to borrow another page from the Madoff analogy, when the inevitable correction does occur, it would not be 10% or 20%: the entire worth of the Ponzi would be gutted. What are these rules? We focus on Section 7422, 24 (a) in the attached Manager’s Amendment.The first one states the following:‘‘(2)(A) Every institutional investment manager that effects a short sale of an equity security shall also file a report on a daily basis with the Commission in such form as the Commission, by rule, may prescribe. Such report shall include, as applicable, the name of the institution, the name of the institutional investment manager and the title, class, CUSIP number, number of shares or principal amount, aggregate fair market value of each security, and any additional information requested by the Commission. For purposes of section 552 of title 5, United States Code, this subparagraph shall be considered a statute described in subsection (b)(3)( of such section. ‘‘( The Commission shall prescribe rules providing for the public disclosure of the name of the issuer and the title, class, CUSIP number, aggregate amount of the number of short sales of each security, and any additional information determined by the Commission following the end of the reporting period. At a minimum, such public disclosure shall occur every month.’’.What this means is that just like with 13-F and 13-G filings for long positions, investors over a certain threshold will be forced to provide to the SEC a listing of all their short positions, which in turn will decide whether or not to publicly disclose all the details about any and all indicated short positions. Of course, any such disclosure will make shorting very problematic for managers who up to this point have been able to tout their long-exposure in certain names without disclosing hedged or shorted counterpositions, with the hope that they will be able to short even more names to witless followers who merely replicate given hedge fund portfolios (yes, hedge fund portfolio cloning is nothing new, and hedge funds are all too aware of how to take advantage of gullible trend seekers). Furthermore, this would likely make hedging particularly difficult for a vast array of hedge funds who do not share the administration’s, and CNBC’s, fervor that all is good in both the economy and the market.The scariest component of this rule is the latitude that the SEC is given
in determining broad policy. As is widely realized by now, the SEC is merely a lapdog for the biggest monied interests, and as such will merely end up doing whatever is in the best interest of such firms as Goldman Sachs which have gotten the concept of regulatory capture down to an art. The second proposed rule is even more peculiar: the SEC will prohibit anything it deems is a “manipulative” short sale, with the definition of said manipulation left entire up to the SEC’s intellectually and reputationally (if not financially) challenged executives:‘‘(d) TRANSACTIONS RELATING TO SHORT SALES OF SECURITIES.—It shall be unlawful for any person, directly or indirectly, by the use of the mails or any means or instrumentality of interstate commerce, or of any facility of any national securities exchange, or for any member of a national securities exchange to effect, alone or with one or more other persons, a manipulative short sale of any security. The Commission shall issue such other rules as are necessary or appropriate to ensure that the appropriate enforcement options and remedies are available for violations of this subsection in the public interest or for the protection of investors.’’.Just like the anti-terrorist act allowed virtually any citizen to be stripped of his rights with no questions asked, if the powers that be determined he or she posed a terrorist threat, so potentially any short sale will have legal ramifications, if the SEC so decides. For example, Mary Schapiro can come out tomorrow and tell you shorting Citi is now verboten. That’s precisely what rule two envisions. The last rule is the most peculiar, as it will mandate broker-dealers to instruct clients they have the right and ability to refuse to lend out their stock to short-sellers. In a time when it is next to impossible to find borrow in a plethora of financial stocks, this will simply further eliminate the pool of shortable collateral. As a result, look for (or rather don’t) an ever increasing number of shares that will hit broker HTB (hard to borrow) lists, which as a result have huge repo rates and/or are simply unavailable. NOTICES TO CUSTOMERS REGARDING SECURITIES LENDING.—Every registered broker or dealer shall provide notice to its customers that they may elect not to allow their fully paid securities to be used in connection with short sales. If a broker or dealer uses a customer’s securities in connection with short sales, the broker or dealer shall provide notice to its customer that the broker or dealer may receive compensation in connection with lending the customer’s securities. The Commission, by rule, as it deems necessary or appropriate in the public interest and for the protection of investors, may prescribe the form, content, time, and manner of delivery of any notice required under this paragraph.’’The combination of these three rules, when passed, will make shorting practically impossible within equities, and with CDS demonized beyond compare, virtually all options (except puts, although we are confident Barney Frank will see to that rather shortly as well) to express a bearish bias in securities will be taken away from investors.And as if that wasn’t enough, the SEC is now expected to adopt a modified uptick rule. The proposal for an “alternate uptick rule” would require traders who wish to short, to post offers at least 1 cent above the best bid, with hitting bid through shorting becoming illegal. What is unknown currently is whether this rule would be effected in combination with a “circuit breaker” rule, whereby the alternate uptick would be enforced only if a stock were to drop by 10% or more in a given session. Whether or not a circuit breaker is adopted, the combination of all these rules will affect numerous algorithms, further making the computer and algo trading bias (the dominant market force over the past 4 months) to the purchasing side. Again, the motive behind all these changes is all too obvious: with the fate of the administration, consumer confidence, and the US economy itself tied in to every tick of the market, the regulators and lawmakers of the US will do anything to destroy any semblance of an efficient market if it makes price drops more difficult. Of course, any deviations from fair value are always be temporary, and the ultimate collapse, when it does occur, will be that much more violent. However, as we have gotten to a point when every single up day in the market counts so that Obama can boast to a naive TV audience what a great job he has done in any given day courtesy of the Dow being up another few points, it appears nobody really cares about an efficient market any longer. The irony is that these regulations will likely push out numerous retail and institutional investors away from open exchanges, and force investors to trade either in unregulated dark pools and other ATS or simply move to foreign domiciled exchanges. At the end of the day, should this Manager’s Amendment pass, it will mark the true beginning of the end for America’s once effective, and relevant, market structure.