Goldman Sachs Tiptoeing Into The Bear Camp

Blokes like Mike Panzer, Peter Schiff & Stephen Roach have been bears for a long time and while it's nice to have such credible allies for the bear case, at times I wonder if we're all a bunch of fucking "glass half full" nutters and the economy will expand ad infinitum, like the mocking, smirking, asshole perma-bulls seem to think.

But when the likes of Goldman Sachs jumps the fence, it means there must be some substance to the bear view... and it must be close.

No need for further comment from me on this article which appeared in The Telegraph:

By Ambrose Evans-Pritchard
Last Updated: 5:43pm BST 27/09/2007

Goldman Sachs has abandoned its ultra-bullish view of the world economy, warning of a likely recession in Japan and mounting risks that US property slump could spread to parts of Europe.

In a new report, "The Global Economy Hits a Crunch", the US investment bank said it was no longer sure that Asia and Europe would be able to pick up the growth baton as America stumbled. It fears that turmoil is spreading beyond the debt markets to the factory floor.

"Much has changed since mid-July, when we wrote that 'the global economy continues to enjoy one of the strongest sustained expansion in modern history'. The mood in financial markets is clearly darker, and the economic data in the developed world is showing signs of wear," it said.
advertisement
<A HREF="http://ads.telegraph.co.uk/event.ng/Type%3dclick%26FlightID%3d22539%26AdID%3d27295%26TargetID%3d5730%26Redirect%3dhttp://www.telegraph.co.uk/portal/main.jhtml?view=CAMPAIGN&grid=A1NoGoogle&pg=/ETHtml/content/promotions/2007/09/06/horrible/index.jhtml&pc=Telegraph%20horrible%20library" target="_top"><IMG SRC="http://adc.telegraph.co.uk/h/house/horrible/HScience_300x250.gif" WIDTH=300 HEIGHT=250 BORDER=0></A>

"Japan's recovery is tottering, with the chance of an outright recession having risen to nearly two in three," said the report, authored by chief economist Jim O'Neill.

It is an abrupt change of tack for the bank known as the "cheer leader" of the global boom. Until now Goldman has insisted that Asia and the developing world are strong enough to shrug off an American slowdown, allowing world growth to keep racing ahead without missing a step -- despite subprime woes.

Often overlooked, Japan remains the world's second biggest economy and top creditor with some $3,000bn in net foreign assets.

Output had already contracted an annual rate of 1.2pc in the second quarter before the credit crisis hit.

There has since been a surge in the yen as speculators unwind carry trade positions, leaving Japan's margin-trading housewives and grannies nursing big losses.

Wages have fallen for the last eight months in a row. They are now down 1.9pc from a year ago, threatening to pull the country back into deflation.

Goldman Sachs feared it was now "inevitable" that consumers would batten down the hatches for a while.

The bank said Europe is now so weak after a clutch of dire confidence surveys in Germany, Italy, France, and The Netherlands that any further rate rises by the European Central Bank are "off the table".

It expects the euro to fall back to $1.35 against the dollar over the next year, and sterling to tumble to $1.88 as the Bank of England pushes through three rate cuts.

The one bright spot is the 'BRIC' quartet of Brazil, Russia, India, and China, all still firing on four cylinders, if slowing slightly.

In a separate report, "Rising Risks to the Global Housing Market," it said that much of global system had succumbed to a property boom that is in some ways more stretched than in the US, with real (inflation-adjusted) house price rises of over 100pc in France, 60pc in Italy, 55pc in Canada, and 72pc in Australia since the late 1990s. The bubbles in Spain and and Ireland have been more extreme.

"Such a widespread housing boom has little precedent in modern history. In those markets where prices have run up the most, and rental yields have fallen dramatically, the risks of a housing correction are likely to have increased materially," said the note, by Peter Berezin.

"The wealth effect for housing is about twice as large as for equities, with consumption falling by about two cents in the short run for every $1 decline in home prices," he said.

He expects US house prices to drop 7pc in 2007 and another 7pc in 2008, as mortgage lenders shut off credit to chunks of the market. "The US is often a leading indicator for what happens in the rest of the world".

Mr Berezin said construction booms usually lead to housing busts lasting several years. Residential construction in the US reached 6.3pc of GDP at the peak of the bubble, the highest since the baby boom in the early 1950s.

In Spain, it has been even higher, averaging 8.7pc of GDP since 2003, and in Ireland it has exploded to 14.2pc, leaving a overhang of unsold property. House prices are already falling in Spain, where 98pc of mortgages are on floating rates that have roughly doubled since late 2005.

Property prices have dropped for the last four months in a row in Ireland.

Mr Berezin said the Goldman's "decoupling" thesis was based on the assumption that the US housing slump was a "country-specific-shock" that would not spill over into other economies. This was now in doubt.

"The spread of global credit risks has introduced a new potential transmission mechanism. If home prices in the key economies begin to fall, this will have an adverse effect on global growth," he said.

Bears on Message

I've been totally slack about blogging the last few days. Partly because not much is happening from my economic perspective (in terms of things to write about) and partly because I am feeling a bit deflated/disappointed at the recent Fed actions. I really feel it is the worst thing they could have done for the health of the world economy in the medium term.

Anyway, while I recover some enthusiasm for writing shit on the internet, have a look at this video. It is Glen Beck interviewing couple of my favourite bears, Peter Schiff and Michael Panzer (who's blog, Financial Armageddon appears in my blogroll)

Rate Cut Post Mortem

As you know I have my own feelings about Helicopter Bens's rate cut. In case you haven't been following along, I think it was an extraordinarily bad decision and each member of the FOMC should be strung up by their balls. I've been dieing to comment from a bush economists point of view (and have been ranting and raving offline), but really wanted a more professional opinion for this blog.

As usual, Mick Shedlock delivers the goods with some excellent analysis in Bernanke's Bullet Misses The Mark. Here is a synopsis taken directly from the article:

List of What's Changed

• Perception has changed.
  
• Any perception of the Fed as being concerned about inflation went out the window.
• Any perception of the Fed as being concerned about the dollar went out the window.
• Bulls are happiest they have been in months.
• The stock market is higher.
• Gold is higher.
• Oil is higher.
• The Prime Rate dropped 50 basis points.

List of What Hasn't Changed

• Mortgage Rates. (Actually mortgage rates rose since last week as the chart below shows).
• Auto Loan Rates. Nearly identical to last week.
• Home Equity Loan Rates. Nearly identical to last week.
  
• The outlook for jobs. (If anything the outlook is weaker judging from the Fed's panic).
• Credit Card Interest Rates.
• The foreclosures outlook did not change. It is still bleak.

The Fundamentals Have Not Changed

• Massive numbers of foreclosures are still going to happen.
• Banks are going to be stuck in huge numbers of REOs.
• Home inventories are still rising.
• The economic ship is still sinking
  
• The jobs market remains grim

Please read the whole article as it makes a whole bunch of sense.

As expected & noted, there has been movement in the markets; The USD is taking it up the ass, and Metals, Oil and other exchange rate sensitive markets are flying. The really curious movement to me was in the long bonds, both in the US and Europe. Since the rate decision, the contracts I follow closely and trade, The Euro Bund and The 10 Year T-Note have been down strongly and in fact accelerating today in big one day moves.

If you don't happen to know what this means, it means that longer term bond yields, which mortgages and other long-term are priced off, ARE RISING, as indicated in the 10 year YIELD chart on the left.

I am on record as holding the view that rates should in fact be rising and I think that once liquidity is normalized somewhat, Bernanke will be forced to raise again. But on the long end of the yield curve at least, the market is doing what the Fed doesn't have the balls to do. Those who have painted themselves into a corner in the housing market won't be getting any relief and nor should they. (Though I do feel sympathy for how the market and mass psychology have compelled them to make unwise decisions. The psychology used by vested interests is very strong.)

In conclusion, the shipwreck is still on course, a .5% cut proves it. The only area where I remain bemused is why equity traders are bullish.

10 Priciples of Economics

"Mankiw's 10 principles of economics, translated for the uninitiated", by Yoram Bauman

This is a really good watch. :-) From Calculated Risk.

Goodbye USD!

0.5% is a very fucking lousy decision.

I'll let the real economists mull over than one, while ignoring the capitol hill sycophants.

At Last! A Voice of Reason.

Sort of. Katherine Mann says hold interest rates... but doesn't think a recession is on the cards. Hmmmmmm.....

The UK Mortgage Lender Implode-O-Meter?

By now just about everyone will know about the Northern cRock bank run on Friday and Saturday. I haven't posted till now for fear of merely regurgitating what is already posted in depth all over the freaking internet.

I have been amusing myself with pictures of queues outside branches like the one on the right... well, OK it's a photoshop job just for fun.

The only problem is that there are a lot of folks who won't be thinking the whole situation is funny at all. There will be hundreds of Northern Rock customers who will be having sleepless nights over the weekend, worried about the security of their investments; like the poor old lady below who stood in the queue for hours to get her money out, only to be turned away at closing time by the local constabulary. I feel for them.

Internet customers are having a hell of a time logging on and accessing their accounts amid suspicions that bandwidth has been deliberately restricted to stem the hemorrhaging of funds from the bank.

Of course everybody from the NR CEO, to the press, to the Chancellor of the Exchequer is saying that the bank is sound and that people funds are safe. But these parties are not known for telling the truth are they? Depositors obviously feel discretion is the better part of valour and taking their funds elsewhere. I can't say I blame them one iota.

Unquestionably, there is no way that NR can continue in it's current form, so basically the first mortgage lender in the UK will very shortly cease to exist.

That makes me wonder if some enterprising Englishman/woman has kicked off a UK version of
The Mortgage Lender Implode-O-Meter, because it might just be the first of many. Sub-prime lending in the UK has been rife and has been hidden by strong price appreciation to date and folks have been able to sell or MEW themselves out of trouble. But with the first month on month falls recorded, those days are over.

Regarding the future of the UK property market, I think there is a sound opinion here in the following video:



No matter what exactly transpires next, (I suspect governments and CBs will desperately try to prop up the boom) The world changed in August and things will be different and harder from now on.

The Myth Of The Perpetual Boom

In "The Age" today there was an article detailing how loan defaults have risen 30% in Australia over the last financial year. Read It.

That's not really what I wanted to concentrate on. There are literally hundreds of articles bringing to attention the signs of a world economy going over the falls. No need to regurgitate too much of that here.

The bit that caught my attention was this statement:

...And economists say consumers who haven't experienced a recession are upping their borrowing to levels more than double their income because they are confident the good economic times will continue.

This is something we bush economists of an Austrian bent have been commenting on for some time now. There are many folk that have either never experienced a recession, or who have forgotten that they can occur.

Only recently I was speaking to quite a successful small businessman who refused to concede even the remotest possibility of a recession... not just in the immediate future, but ever! LOL! Anyway, I changed the subject pretty smartly to conserve a friendship.

I notice even experienced economists who speak on Bubblevision seem to imply that recessions are just not on the cards anymore.

WTF?

I think the contrarian indicator is invokes waaaaaayyyyyy too early these days, (It's fashionable to go against the tide ). I often think it's a good idea to fade these "early" contrarians, but in these days where everybody knows about the contrarian indicator, and hence its inappropriate use, surely there must come a time to fade the faders who are fading the faders. lol.

In other words, in the quote above, is there a "genuine" contrarian signal? There sure are lots of bears about at the minute, but the great unwashed masses are still unrelentingly bullish.

Riches to Rags In The City

In the last few posts I've been speaking about the now well known problems in the credit markets, and how this is starting to affect London property prices. Of course yje property perma-bulls refuse to concede that falls in prices are possible; real estate only ever goes up don't you know?

History and a few deft keystrokes in Excel disprove that, but for falls to become a reality, there must be vectors that exert downward forces. I've mentioned the vanishing bonuses, but how about unemployment? I'm not talking about factory workers and builders any more, I'm talking about suits.

Check out this blog from the BBC's Robert Peston LINK:

Scything the City

• Robert Peston
• 13 Sep 07, 07:45 AM

The humungous bonuses trousered by many investment bankers may seem a trifle de trop.

But it’s not a stress-free existence. They live in an eat-or-be-eaten world and are in work for as long as they are economically productive - and barely a second longer.

So brutal redundancies are now only days and weeks away, as it becomes commonly accepted that the turmoil in financial markets will depress certain lines of business for months if not years.

The boss of one investment bank tells me he expects a first wave of job cuts that will see individual banks reduce their headcounts between 5 and 15 per cent.

And he says he wouldn't be surprised if that was followed just a few months later by a second wave of similar or even greater magnitude.

First out the door will be many of the creators of the current crisis: the manufacturers and traders of assorted asset-backed securities that you can hardly give away right now; all those debt whiz-kids who engineered the poisonous collateralised debt and loan obligations; the banking servants of a hedge-fund world that’s shrinking fast and of a private-equity industry in cryogenic storage.

Should we weep for their plight? Some of you will scoff at the thought. It’s a big hello to schadenfreude.

Actually, there could be one or two benign consequences from the slaughter of the not-so-innocent, such as a deceleration in the rampant inflation of central London property (okay, I know this is not a universal good).

But don't think we'll get away scot-free.

The economy called Britain is built on financial services (though more by accident than design). Something over a third of our overall economic growth has been generated in recent times by the City and financial services.

Lean times in the City means slower growth, less wealth to spread around and a substantial dip in the Treasury's tithe.

When the bubble is pricked, no umbrella is big enough – we all become a bit damp.

There are still corpses to float to the surface in this whole credit crunched scenario IMO. Bearing in mind the gravity of what happened in July-August, things are just a bit too quiet to be real.

What Are Gold & Oil Telling Us...

...if anything?

Well yeah, it's partly to do with the dollar doomage, but I think there is more to it than that. Both gold and oil are threatening, or threatening to threaten multi year highs. In the case of oil, all time highs.

First gold: There is the gold is money argument, so it's natural that gold will rise as the dollar tanks. I don't go along with that 100% but what I think matters nought. If enough folks with enough capital think so, it is so. Perception is reality. Add to that the speculative froth once the public gets onto the bandwagon and in the current environment we could see some real boomage here. To a certain extent, I think this could be starting to happen. The gold bugs are certainly starting to froth at the mouth on all the trading forums.

weekly continuous gold

In recent months it's been grinding sideways frustrating the crap out of all but option writers, but this move is starting to look fair dinkum.

On the the other hand, oil is threatening to take out its all time high. There are probably plenty of bullshit fundamentals to justify this, and if of an apocalyptic bent, one simply must be a crude oil bull.

weekly continuous west texas sweet crude

The $64,000,000 question is the future of the price of oil in the medium term, presuming the world economy goes into recession. It would be expected that a recession would lessen oil consumption and result in declining prices, sans any killer 'canes obliterating the Gulf of Mexico or similar.

Long term, you just have to be a bull.

I'm glad I have some rudimentary charting skills because the fundamentals are often too full of biases, bullshit, short term considerations and rigs getting blown over.

An all time high in pretty short shrift seems like a high probability in the near term.

Back to the question posed at the beginning. Is this trying to tell us something? Something other than the purely native fundamentals of these two commodities? If it is, I suppose it will be loud and clear in a relatively short space of time.

The Streets of London

For a couple of years now, there has a been a growing crowd that have become bearish on the UK property market. The bulls cite a number easily disproved fallacies as to why they think property prices will rise well beyond inflation ad infinitum. Shortage of housing, we are an island, high immigration etc etc etc, all of which were cited in the last boom did nothing to stop the bust when it came in the early 90's.

A study of business cycles and a few columns in Excel will quickly dispel the mathematical absurdity of the perpetual boom. Indeed, regional England has been seeing price stagnation, and even falls in some areas. Even Northern Ireland has apparently hit a wall as desperate vendors drop asking prices to shift their overvalued hovels.

Ahh but London, that paragon of all that is coveted in this bourgeois ego infected planet; Harrod's, Covent Garden, Mayfair, the West End and so on, has been stubbornly, defiantly rising in the face of all rationality. There have been two main reasons for this. The UK's favourable tax treatment of non residents has seen billions of pounds pouring in from wealthy foreigners, snapping up all the fashionable real estate. Most recently, this has been coming from the Russian oligarchy. The second factor is the absurdly oversized bonuses financial sector employees have been receiving, due to the recent credit and equities boom.

I mean, what do you do with a Christmas bonus that would make the GDP of a small African nation look like pocket money? Why, buy real estate of course!

We bush economists have been wondering though, how the recent credit market heart attack would effect the City boys. The answer came via the Financial Times:

City bonus fears hit prime market

By Jim Pickard and Sharlene Goff

Published: September 7 2007 20:16 | Last updated: September 8 2007 05:18

Property purchases are coming under pressure in the wealthier London districts after gloomy forecasts for end-of-year City bonuses.

Estate agents have reported some deals falling through, while mortgage brokers have seen a number of active buyers put their property searches on hold, for fear they will not receive the bumper payouts they had hoped for.

House prices in areas popular with City professionals, such as Mayfair, Kensington and Chelsea, rose at their slowest pace for a year last month as the impact of the credit crunch took hold. FULL STORY

While the article states that rises have merely slowed down and no falls recorded, it can't be long before there are MoM falls as the credit crisis plays out.

Now things get interesting. The signs of an impending Austrian bust are everywhere and the ball is in Bernanke's hands, though the general consensus is that he can only provide a rear-gaurd action, giving the smarties enough time to get the hell out of the way.

Sub-Prime Mess Contained

A leading economist said today that there is no evidence that the sub-prime contagion will spread beyond the stratosphere. Meanwhile, the credit crunch is starting to involve the cheap tat buying public.

Families have been warned of a looming credit drought as banks and building societies stop handing out cards and overdrafts to hard-pressed households

Industry experts have said that lenders are clamping down on debt applications for fear that borrowers default as the economy worsens.

It is the latest evidence of how the financial markets crisis is affecting households and follows news that mortgage companies are primed to increase their interest rates, causing more hardship for hundreds of thousands of households due to renew their home loans in the coming months.

Equifax, a company that provides credit checks, said households would find it increasingly difficult to borrow money in the coming months, as lenders started to refuse more and more applications. FULL STORY

I think this will have a quantum effect on retail sales... perhaps even accelerate mortgage defaults. I know plenty of folks who are doing the credit card boogie to make their over-committed ends meet, all the while building more and more debt. Another signal we bush economists take note of.

Jobs

So Wall Street economists were expecting ~+115,000 on the NFP number.

Really?

The building industry is hemorrhaging jobs from the great gaping hole in its aorta and I suspect there would be a few real estate broker sending CVs around at the moment too; and the NFP was a shock?

"It's a major shock to the market," said Peter Cardillo, chief market strategist at Avalon Partners. "If the job market continues to weaken, fears of a recession will continue to accelerate, calling into question corporate earnings."

You have to wonder about economists. I mean I have an interest in economics and though no formal degree, I would consider myself what would be termed here in Australia as a "bush economist". This is someone who basically has been fucked by not knowing about business cycles before and has learned to "sniff out" when things are starting to get out of whack.

We bush economists have been worried about sub-prime, stretched asset values and rampant malinvestment for a couple of years now while the smirking Wall Street assholes have been bullshitting on about Goldilocks economies.

We have also been wondering how long birth and death models and other such nonsense could disguise the real state of employment. When you get an actual drop of 4,000, it's time for folks to pull out their CVs and polish them up for a potential mass mail out.

But look and the bright side, it's another factor for Uncle Ben to justify a rate cut.

The logic goes: slowing economy => rate cut => bullish => market rally

Yep, Goldilocks rules... along with other fairytales

So WTF Exactly, is Going On?

Is the Gold upage a harbinger of more uncertain times? What the fuck is going on? B-52s flying around with nukes by "mistake", Russian bomber fleets flying with Jet fighters in puruit?

Holy Crap!!

US B-52 in nuclear cargo blunder

The US Air Force has launched an investigation after a B-52 bomber flew across the US last week mistakenly loaded with nuclear-armed missiles.

It follows reports in the Army Times that five missiles were unaccounted for during the three-hour flight from North Dakota to Louisiana. FULL STORY.

... and then:

U.K., Norway Send Jets to Intercept Russian Aircraft (Update2)

By Robin Stringer and Sebastian Alison

Sept. 6 (Bloomberg) -- Four U.K. Royal Air Force Tornado jets were launched to intercept eight Russian strategic bombers, the British Ministry of Defence said. Two aircraft from the Norwegian air force also trailed Russia's planes.

The RAF Tornado F3 jet fighters were scrambled early today to intercept the Soviet-era Russian bombers ``which had not entered U.K. airspace,'' the ministry said in an e-mailed statement. The ministry didn't elaborate on how close the RAF aircraft got to the Russian planes. FULL STORY

This is a rather apocalyptic development and could explain gold why gold is getting of its arse and doing something. Renewed Cold war tensions anyone?

Still some ways to go before gold looks like a new trend, but it's been worth paying attention over the last few days.

Eyes wide open for a couple of reasons here.

Gold Heads Up

Good old gold! It never ceases to raise the pulses of those enamoured with the yellow metal and trading forums across the globe are abuzz with gold's move today.

One would think that I would be a gold bug, what being of an apocalyptic bent; and sure I have a few obligatory Krugerands etc. It's one of the futures contracts I trade too... why not?

To me it's just another commodity and it's loose inverse relationship to the dollar can be seen in several commodities, but a hedge against a financial apocalypse? Maybe. For sure gold will soar (in dollar terms) if the grenade the financial system has in its hand blows up in its face, but so will other commodities such as silver, copper, oil... maybe even ags and softs. And you can bet your arse I'll being buying with ears pinned back if that happens.

In the above chart, which has the US dollar index plotted also, you can see the loose inverse correlation. But it is very loose. To me it's not a good hedge for the dollar, really. So I trade it purely on chart action, with a lazy ear on the bullshit fundamentals.

Chart wise, today's move is interesting in that it takes us up to supply line and so waiting to see if it breaks out, but hell's bells, nothing to really have an orgasm over. Certainly if this was a stock chart, it would be mildly of technical interest and in this context it is hardly worth going agog over.

But the thing with gold is that by the time it is really interesting, it good be too late, so building a bit of a position in here makes some sense.

But I'll leave all the salivating to later... possibly

Leads From Japan

Japan is the worlds second largest economy on earth by far and now looks to be leading the world in the race to recession, as reported in The Telegraph.

As the latest weak data hits, optimists are now few and far between, writes Ambrose Evans-Pritchard

Japan's economy has slowed sharply over the summer and may now be on the brink of recession, dampening hopes that Asia will buttress world growth as America battles the sub-prime housing crisis.

In the latest grim data, Tokyo said wages had fallen for the past eight months in a row. The cumulative fall over the past year to July has been 1.9pc, evidence of how intractable deflation can become once lodged in an economy. Business investment fell 4.9pc, with the pace of decline gathering speed in recent months.

The seemingly endless string of weak data from Japan comes amid mounting concern in Washington that the US economy is starting to buckle, and possibly tipping into a severe slump.

And a couple of other snippets:

*According to Bloomberg reports, the mood at the gathering turned ever blacker as speaker after speaker warned that the economy may be on the cusp of a sudden downward dive.

*While Fed chairman Ben Bernanke said the bank would "act as needed", he cautioned the market not to expect an instant bail-out. "It is not the responsibility of the Federal Reserve to protect lenders and investors from the consequences of their financial decisions."

*Japanese investors have taken a beating on the yen "carry trade", where they borrow in Tokyo to chase higher yields around the world. The Bank for International Settlements said in its quarterly report yesterday that the overall yen carry trade has reached $1,050bn and the Swiss franc sister trade is $678bn.

Lots more in the full article.

The last point brings me to the inevitable chart. The Yen has been a useful leading/confirming indicator for movements in the US stock market. The chart below shows the recent action of The JPY/USD futures in candles with the S&P500 in bars and show the clear inverse correlation between the two.

This begs the question: Does the unwinding of the carry trade have implications for the fortunes of the US stock market, because the is cause the liquidation of stock positions? Or is it the other way 'round: Does the liquidation of stock position cause the repatriation of Yen, resulting in the unwind?

I don't know and would be interested in the answer if anyone has data on this.

In any case, the technical picture in the Yen looks bullish above the trendline. My best technicians guess is that it remains support. (50/50 proposition of course) That would not be good for the indexes.

In any case, Uncle Ben seems reticent about bailing institutions out of malinvested trouble. Could this mean he will hold rates in September? That could well spark off another savage sell-off.

According to Austrian economic theory (as per the videos I posted a couple of days ago), that would be the best course of action, just let it tank, have a speedy liquidation of malinvestment, let the flaky institutions/businesses go to the wall and get on with life after that. I've always thought that too.

Then we could all have the prospect of a "healthy" growing economy again. It is just a shame political imperitives and demands for institutional welfare intervene.

September Divinations

Always a useless exercise, predicting the future. However armed with a few statistics, I guess we can make a better "guess".

Anyone who has read CNBC over the weekend will have had the "heads up" that September is statistically the worst month of the year, set out in table form from their site:

Most have October locked in as the scariest month because of the few crashes that have occuredin October, but in actual fact, in most years October is up. Apart from those crashes, it's usually a good month. It's September that has quietly put in the hard yards as the crappiest month of the year.

For those who like a more graphical format, here is a bar chart I found at The Ducster's site:

Add to these statistical probabilities, the problems in the credit markets... yeah, yeah I know it's gone quiet on that front. It's very quiet, almost too quiet. I don't believe the problems have gone away or have been resolved, just a dearth of news on the subject; we don't really know what's going on deep in the bowels of financial institutions. According to my few little contacts in the institutions, they themselves don't know the extent of the problem, so everybody is keeping mum.

If the news breaks the surface the surface again, it could be truly fugly.

On the other hand, there is the possibility of the morally hazardous rate cut. In this interest rate obsessed stock market where rates are seemingly the only important fundamental, that could send the the permabulls into a muck lather buying frenzy.

I guess it all boils down to what corpses float to the surface in the next two or three weeks, but I'd be less surprised by new lows than new highs... not that I'd be surprised by new highs. There are still plenty willing to ignore the fact that we are likely to be moving into a credit crunched period of the cycle.

Austrian bust anyone?

Lessons in Economics

Here is an excellent series of lectures on the Economic cycle from the Austrian perspective. (My favoured model)

Business Cycles, Part 1 of 4 - Introduction, Prof. Krassimir Petrov

Business Cycles, Part 2 of 4 - Business Cycle Indicators, Prof. Krassimir Petrov

Business Cycles, Part 3 of 4 - The Austrian Boom, Prof. Krassimir Petrov

BusinessCycles, Part 4 of 4 - The Austrian Bust, Prof. Krassimir Petrov

Each is over an hour and essential viewing for anyone interested in economic cycles.

Photo - Ludwig Von Mises

Cynical Responses to Bush's Initiative

Ah yes, the President himself rides in on his white stallion to save the poor sub-prime defaulters. And my, what cynical responses from pragmatic bloggers:

*Ritholtz says Politics as Usual

* Mish parses the real thought process behind the initiative

*The Fundamental Analysist is wondering why Bush is asking Paulson to look into the sub-prime mess when Paulson doesn't even think there is a problem.

* The irony is not lost on Financial Armageddon either.

Normally accusations of cynicism have a pejorative connotation associated with them, however in this case, the cynicism is entirely justified. Antisthenes, the founder of cynicism, would be well proud.

On the other hand, the goofy permabulls have an entirely different view.

*The Fly says Fuck you, we're going higher.

In the short term, they are probably right.

The World's Oldest Blogger

At 107 years old Olive Riley is the world's oldest blogger.

Good Morning everyone. My name is Olive Riley. I live in Australia near Sydney. I was born in Broken Hill on Oct. 20th 1899.Broken Hill is a mining town, far away in the centre of Australia. My Friend, Mike, has arranged this blog for me. He is doing the typing and I am telling the stories. He thinks it’s a good idea to tell what’s going on. He already made a film about me a few years back and people liked that, so they might like this blog too, he says. We’ll see.

Lots of interesting stories, check it out: http://www.allaboutolive.com.au

The Correction in Context

A timely post from Ducati over at Shenandoah Capital regarding historic, verses the current decline. It kinda puts the current squealing of Wall Street assholes into context. i.e. Puleeeeze, shut the fuck up.

The following charts are from Jim Stack.

What he has done is take the most recent high in the Dow Jones Industrials, 14,000 and then chart the various declines using that 14,000 high as the starting point. The point being made, is that the current decline comes nowhere near a historical bear market, and if this pullback is causing you undue stress, then, quite honestly you probably have no business in the market.

The Fed Guessing Game

Perhaps every person in the world who owns at least a token parcel of TelstraII shares is wondering what is going through the minds of Uncle Ben and his fellow FOMC (or is it the PPT) cohorts. The Wall Street assholes have been screaming for a base rate cut ever since the sub-prime grenade blew up in their faces.

Most sensible commentators not reliant on fee income caution against such a move; more booze for alcoholics is the basic thinking.

Now we learn that the US economy grew at a 4% rate in the last quarter.

The U.S. economy grew at an annual rate of 4 percent in the second quarter, as strong business investment led the fastest pace of expansion since early last year, the government reported Thursday.

The Commerce Department raised its estimate of gross domestic product -- the measure of total goods and services output within U.S. borders -- from a 3.4 percent gain that it published a month ago. That was in line with Wall Street economists' forecasts and far outstripped the first quarter's anemic 0.6 percent rate of expansion.

Admittedly, those figure are for the period before the "credit crunch" and the above article points out that it is not likely to be sustainable, but based on those figures, how can the Fed cut? Other sections of the economy concur that things are just fine and dandy.

I have managed to convince myself that they will cut, caving in to the Wall St assholes, but equally remain convinced that it will be a very bad decision. As many point out, it might not make a hell of a lot of difference, apart from providing for a brief rally. Ultimately, many think we are headed for recession.

If you detect some cognitive dissonance in the above, you are right... mixed messages abound.

So my guess is they cut.

WTF are "Normal Conditions" Uncle Ben?

Well I got a timely kick up the arse for not keeping up this blog, so an update from my cognitively biased point of view. (... and you think you're not? LOL)

Of course, in the intervening time I've had a fiddle with my blog template, as I do. And also of course, I've fucked everything up, as I do. LOL! So now I have to rebuild my blogroll and all the other shit I had in my sidebars. Anyway, I digress.

Interesting article at CNBCs site today... actually it wasn't interesting at all, more speculation of interest rate cuts and all is going to be OK nonsense. Read it here. The statement that caught my eye was this:

Bernanke and his central bank colleagues "expected a return to more normal market conditions," but they recognized that might not be the case, according to minutes of the closed-door meeting released on Tuesday.

I thought to myself: What the fuck are "more normal market conditions" then? Resumption of the bubble economy, the Goldilocks fairytale, the ridiculous discounting of risk?

Apart from the credit market problems as highlighted by the Cramer buffoon a couple of weeks ago, a 10% correction in the stock market every now and then is pretty much..... ummm, normal. What is abnormal is how easy it is, still, to get credit. at least in this country and the UK. It's abnormal that asset values are so fucking stretched (and don't give me the "stocks are cheap" bullshit; they aren't), particularly real estate.

I still don't think there will be a "crash". The goverments' (plural) willingness to intervene is all too apparent and obvious, that is unless something big-time happens. However I would be surprised to see a new high for a while.

Meanwile the stock market has provided a few nice short swing setups. That always make a bear happy.

POP!

OK what's this dumpage all about? The excuses proffered so far:

*Sub-Prime Contagion
*Removal of uptick rule for shorts
*Yen carry trade unwind
*Funds cashing out to build a war chest.

Let's look at these one at a time.

*Sub-Prime Contagion - Well Duh!!! All the Wally's who said it was all contained should be tied up to posts and their tongues cut out. Of course it was going to take out the rest of the economy... 'nuf said?

*Removal of uptick rule for shorts - Absolute BS! Institutions have been able to do it (shortsell without an uptick) via derivative proxies forever. It's only the small fry like us that can now do this now... and we have always been able to do it with futures... erroneous at best.

*Yen carry trade unwind - Empirically, this is not only back on the agenda, but looks to serious. While the Dollar has been in a strong retrace against Euro, Pound, AUD etc, it is getting absolutely poleaxed by the Yen. The carry trade is unwinding and unwinding fast.

*Funds cashing out to build a war chest. - According to at least one money manager, the evidence is in the oilers being crunched in the face of rising crude. Conclusion - the funds want CASH.

... and look at treasuries. There is mountains of cash going there in the face of a crising interest rate environment as safe haven. Expect some volatility there!

IMO, This is the beginning of the credit bubble apocalypse. The $417 is finally hitting the fan. This is not to say we go straight down from here, but we should be aware of that possibility... and at least expect massive VOLATILITY.

Cheers... be careful folks.
__________________

CDOs and Toxic Debt

From Australian TV ABC Lateline program. Economics reporter Stephen Long talks about the US sub-prime mortgage market , Collateralized Debt Obligations (CDOs) and the collapse of two Bear Stears hedge funds, and the potential for this to set off a global credit crash.

Quote: "The day of reckoning is nigh"

Bond Apocalypse Averted - For Now

Well my picture perfect 10yr t-note trade with all its bearish connotations has been scuppered over the last to sessions by none other than, err... the bears.

NEW YORK, July 10 (Reuters) - U.S. Treasuries rallied on Tuesday as investors poured out of stocks and speculative bonds for the relative safety of U.S. government securities.

The drive to Treasuries was fed by mounting concern over subprime mortgage debt and the deteriorating housing market that could also hurt U.S stocks, analysts and trader said.

Earnings warnings from retailers and home builders and also credit rating agency Standard & Poor's statement that it may cut ratings of some subprime loans and is reviewing its ratings of collateralized debt obligations were all factors hurting equities and nongovernment bonds.

"It has to do with the S&P headline on subprime. Credit spreads are blowing out. The fear is that they will force selling by those investors who can't hold on to these low investment-grade bonds," said Carl Lantz, U.S. interest rate strategist at Credit Suisse in New York. >>MORE<<

Interestingly, the technically sloppy short setup on the EuroBund has turned up a better looking long trade from a nice double bottom. A long case good certainly be made for the US contract as well, perhaps more so... but I was short. :-P

What has actually happened is that my bond apocalypse has turned into a USD apocalypse, with basically the same reasons quoted; sub-prime/housing slowdown blah blah. This has caused quite some technical damage to the USD index with new lows printed.

For the bulls it really is head in the sand time (if they want to stay bulls). In my humble and ill-educated opinion, the anglo economies are fucked, and are living on borrowed time (and whacking great piles of borrowed money). It will just take a bit of time for muppets to realize this fact.

The precise route by which this financial apocalypse plays out though, is anyones guess.

Weekend update on Treasuries

Just a quick chart update on my latest obsession in the treasury markets. The short trade setup triggered nicely and has continued in the desired direction. The 10 year T-Notes that I trade are now roughly at the first point of possible (and tenuous IMO) support and not really showing any signs of stopping at this stage.


The other contract I follow is the EUREX Euro Bund. Although the setup wasn't as technically crisp as the t-notes, it was still a valid short setup that triggered a bit earlier while the yanks were messing around and tyeing firecrackers to their neighbor's cat's tail and other pyrotechnical frivolities.

The bund is actually now testing contract lows, a point interest rate obsessed equity investors deem to have missed at this point... or are ignoring.


... or maybe they are expecting support.

Next Leg Down For Treasuries?

Earlier in the week I highlighted a setup in 10 year t-notes. Aggressive traders may have taken a short trade straight of that setup, others may wait for a confirmation of price breaking below the trendline. Those waiting got their trigger today.


However there was clue that this would definitely break down in the price action of the Eurobund, which put in a nasty down day on tuesday and has continues down since.

Now things get very interesting, and not just for bonds. Equities are not likely to react well to lower bond prices and the US indices are off a few points as a result.

Technically, there are some obvious points of possible support, but below Junes low folks will likely start shitting themselves. As several commentators have pointed out recently, the market is starting to do what the Fed refuses to do... and should do.

Elswhere, the Brit have jacked rates up another quarter (but should have gone .5), and the Eurozone is announcing later today.

Peter Schiff verses Everyone

Peter Schiff on Kudlow and Company

And the winner is... well that depends on your cognitive biases.

Always entertaining.

10 Yr T-Notes Setting Up

In the early part of June, US treasuries were responsible for some extreme consternation in the equities market due to to their rabid decent into the nether regions of recent price history. (Inverse relationship to interest rates. Bonds down = interest rates up, for those who don't know). From the highs in June at ~108½ on the September 1o year T-note contract, prices plunged all the way to under 104 in a month.

This really caught the attention of an interest rate obsessed equities market. Although the chart doesn't really show it, it put the wind up those who are awake to the risks.

The recent retracement of that move has meant that folks have lapsed back into their easy credit induced trance. However at this point there is an interesting technical setup shown here on the above mentioned contract.


The retracement has taken us to 50% of that move, which followers of Fibonacci and Gann swear is significant. For me, enough follow this theory to make me sit up and take notice, particularly a setup as clean as this.

Aggressive traders might already have gone short already; others may be looking for some confirmation in the price dropping through the support line. I'll be interested in what else happens if the bond dumpage continues.

It could get very interesting.

A Look At Metals Volatilities

Implied volatilities in the metals I trade (gold, silver & copper) are at the moment, at somewhat of a low. If we go by the traditional option dogma of buying options when vols are low, then on face value, metals options are a buy.

But are they. In my experience, it is not as straight forward as that. Well if you have a clear directional view of an imminent move, then sure, buy a call or a put, or the directional spread of your choice.

The first thing about low volatilities, is that they can stay low for a LONG time, or even go lower. This is generally not a good thing if you are long options. An option trade is also a volatility bet to a greater or lesser degree, depending on the strategy. When we buy options, we are long "vega" which means we preferably want volatility to increase, or at least we want the underlying to start trending. If not, we get chopped to pieces by theta (time decay). If volatility decreases, we lose again.

Lets have a look at the volatility picture of Gold (Copper is quite similar):

IVs are basically a third of what they were a year ago and as yo can see they have been even lower. If the unceasingly bullish Gold Bugs are correct, gold will skyrocket as this credit bubble unravels. Not only will gold fly, but gold IVs will also go berserk. Equally though, I have read credible articles that say go will go the same way as housing, into the pits. Who knows?

The big question is if gold makes a big move, when will it be? Well I have no freakin' idea, but let me show you Silver IVs over th last 2 years:

A similar picture to gold, but with an interesting lift in IV on the back of last weeks dumpage.

Whether this means anything or represents an opportunity, I am pleading the 5th, but I say it's interesting enough for a post on my blog and something to definitely follow.

Stay tuned.

Soybeans, Cotton...Big Day

News this morning in the grain markets revealed that the number of acres that have been planted with soybeans is seriously deficient. This is bullish news for traders in the bean complex with Soybeans going limit up early in the session... thats 50 points!

Those that positioned themselves long in this weeks consolidation at around the 840 cents level will quite naturally be ecstatic with the November contract closing the day at 883.5 cents.

Wheat and corn joined in the volatility but with big moves DOWN.

Cotton also gapped up on similar news of lower acerages.

Farmers trying to cash in on the demand for corn is where those soybean and cotton acreages have gone to, so it is reasoned that there may be an excess of corn come harvest time.

Charting Support & Resistance on Futures... Hmmmmm

Charting support and resistance on commodity futures charts can be a bit tricky. The futures price will be the cash price of the commodity plus carrying costs, so deferred contracts can be higher priced than the nearest contract as the physical commodity may have to be held in storage longer. This is referred to as contango.

However, some factors may make the deferred contracts price less than the nearer contracts. This may be lack of immediate demand for deferred delivery, new crop verses old crop supply, as a couple of quick examples.

This has ramifications when looking at charts over the longer term. When looking at a chart of a single contract where cost of carry has been priced in that cost will naturally decay as time goes by, similar to, but nowhere near the extent, of an options contract. This also affects the continuous chart. When one contract expires the next contract is simply tacked on to the continuous chart. The expiring contract's cost of carry will have decayed away to zero, while the new contract being added will have carrying costs reflecting the time till expiry.

Consider the two charts below. The first is The August 2007 contract and the second is the continuous contract.



Notice the difference between the two charts. The August contract shows the recent $70 resistance as have just been broken, yet the continuous shows resistance at a lower level. It also shows some other differences shown by the lower red line in each chart.

This is a profound difference for those used to charting share prices where such factor do not exist.

My approach is to chart short term support and resistance on the individual contract, but to chart long term support and resistance on the continuous chart. Where is the dividing line? That's a tough one; over the time frame of the above two charts is a grey area which I don't have an answer for.

In the end it depends how you trade and what your view of technical analysis. I'm more of a swing trader so the long term charts are more of an academic interest and do analysis on individual contracts, but that's just my way.

Something to be aware of for chartists.

Oil above $70... Again

Yesterday we had the news of dwindling Gasoline stocks resulting in a nice setup for a potential flag breakout in Crude. Not surprisingly, demand on Crude has pushed the price up for both a technical break of the flag, but also overhead resistance at ~$70.

Longs will be watching closely at this level to see if they can break the $70 convincingly.

Oil Hits $70 a Barrel

Is Gold Real Money, Or Just Another Bloody Commodity?

I've often pondered this question myself. From my own observations as an inveterate chart watcher, sometimes it behaves like money and sometimes like a commodity. A conundrum.

For some clarification on this Mick Shedlock has written a great article on this topic, check it out:

Misconceptions about Gold

The obligatory chart shows the August contract caught in this downward sloping channel with little swing trades possible of the declining support and resistance. In the absence of any meaningful trend in the bigger picture, this is my preferred way of playing Gold at the moment.

Oil Chart Juicing Up

News on Gasoline stock released today:

http://www.philly.com/philly/wires/ap/business/8204342.html

Oil Tops $68 on Gasoline Supply Concerns
J.W. ELPHINSTONE
The Associated Press

NEW YORK - Crude oil and gasoline prices rose Wednesday after a government report showed gasoline inventories unexpectedly shrinking last week.

Heating oil prices also increased after a surprising decline in distillate stocks.

Light, sweet crude for August delivery on the New York Mercantile Exchange gained 31 cents to $68.08 a barrel in morning trading. The contract had fallen $1.41 on Tuesday.

Brent crude futures edged up a penny to $70.18 on London's ICE Futures exchange.

Gasoline futures rose less than a half-cent to $2.2515 a barrel.

The Energy Department reported Wednesday that gasoline inventories dropped 700,000 barrels in the week ended June 22, contrary to the 1.1 million gain that had been expected by analysts polled by Dow Jones Newswires. Total gasoline stocks are well below the lower end of average for this time of year.

This news bumped up the price to the upper edge of the little flag shown on the chart.


The obvious point of interest is whether this breaks out tomorrow and has another shot at $70 on the August contract

A Change

Hi Folk, (This is not a typo, there is only one person tenacious enough to check this blog for new posts. That's my wife... and only cause I just told her.)

As intimated in an earlier post, I've been moving in the direction of commodity trading. I've been dabbling in commodities for some time while predominantly trading stock options, but over the last year things have changed. I've become predominantly a commodities trader who dabbles in a few stocks and their options.

There are a few reasons for this which I won't bore you with right now, but mainly I am attracted by the non-correlated returns offered by non-related commodities and financial futures.

You will have also noticed that I've changed the name of the blog. Obviously I wanted to reflect my change of direction, but also to out myself as a bear. (Those that know me know this already) "Trading the Apocalypse" seemed to reflect all the bullshit happening in the world right now. Wars, global warming, terrorism, mortgage fiascos, perpetual bubbles waiting to pop, all point to some "exciting times in the near future. Perhaps an apocalypse? Perhaps not. LOL

So what I want to do here is comment on whats happening in the various markets; of course throw up some charts on the action as well, nothing new there. But maybe I'll have a bit of a vent every now and again, bitch about house prices, make enemies on the other side of the political spectrum (wherever that lies), give out fuckwit awards, stuff like that.

Maybe even a stock of the day once in a while.

Anyway, this is purely for my enjoyment and as an outlet for my frustrations. If you feel like joining in (that is, if anyone apart from my Mrs reads this) please do so.

Writing Commodity Options

A few of you still reading this infrequent drivvle of mine have mentioned the writing of options over commodity futures. I don't have enough experience with commodity options to be authoritative, but I have read what I think is an excellent book on the topic and it deals extensively with written options on futures.

This book is written by a bloke called Stuie Johnston. Some have criticized it for its conversational and irreverent writing style, but I found it not only occasionally hilarious, but very good at setting out a philosophy and methodology for premium collection on commodity futures.

Be prepared for a few statistics and discussion on seasonality... and especially what Stu refers to as NON-seasonal trades.

Check it out

He also runs a very good seasonal trading database site that if/when I have a crack at this, I will definitely subscribe to. www.timeandtiming.com (no financial connection blah blah)

What You Didn't Know About Time Decay

Time decay is known by the greek word "theta" and what everybody knows about theta is that it accelerates in the last month of the options life, losing a substantial whack of its value in the last few days.

In every option text I've ever read, theta is universally depicted by a graph that is something like the following:



This is a graph of the time value of the last 90 days of an ATM option. As you can see, the rate of decay is more or less linear up until the last 30 days, whereupon it starts to decay at an accelerating rate, losing the remaining value very quickly in the last few days.

This is proof that if you short options you should choose options with about a month remaining because that is when most of the decay is.

Or is it?

The above is certainly true for At The Money options. But what about Out of The Money options? What the textbooks don't tell you is that for an option that is somewhat OTM (or somewhat In The Money for that matter) is that the above scenario is not quite true. The characteristics of theta change, the further we go OTM or ITM.

Lets look at a theta graph for an option that is somewhat OTM:



Lo! It seems in this instance, that theta does not accelerate in the final 30 days at all, but rather DECELERATES.

If we are short OTM options we will collect more theta by writing expiry further out... 60 or perhaps 90 days and wind them up before the last month.

This is where "options education" can sometimes be erroneous and it pays to observe, notice things, play around with your strategy modeler and/or excel spreadsheet and really become intimate with these option concepts. It does pay.

Margin Hysteria Rules

Many folks are all a-flutter over the new Margin rules that set to be introduced this April. Most of the hype seems to centred around the leverage available under new rules.

Hitherto unavailable leverage IS available on a some strategies, most notably, buy/writes. But the most amusing thing is ersatz experts waxing lyrical about this amaaaaaaazing leverage now available on such things as married puts and collars.

This really ignores simple synthetic relationships between strategies. Possibly intentionally.

For instance, I read one post on a bulletin board from an allegedly ex-market maker, extolling the virtues of the new leverage married puts will have. Well excuse me, but a married put is just a blinkin' synthetic call! The leverage has been available all along!

It has gotten the stage where folks are predicting either 1/ a leveraged, LCTM style perfect storm, taking out the whole market, or 2/ an incredible bullish flourish as all and sundry massively add to their portfolios, courtesy of this "new" leverage.

I'm predicting business as usual with some small scale stupidty around the edges, just like normal LOL

New Margin Rules For Option Positions

This was released in the middle of last month, and while trumpeted by a few option education firms, seems to have slipped by largely unnoticed by a lot of the retail trading community.

SEC APPROVES CBOE'S NEW PORTFOLIO MARGINING RULES TO BENEFIT CUSTOMER ACCOUNTS

CHICAGO, December 13, 2006 - The Chicago Board Options Exchange (CBOE) announced today that the Securities and Exchange Commission (SEC) approved amendments to CBOE rules that allow for expanded portfolio margining for customer accounts.The effective date of the amendments is April 2, 2007.

Today's action expands the scope of products eligible for portfolio margining to include equities, equity options, narrow-based index options, certain security futures products (such as single stock futures), and unlisted derivatives. The SEC approved portfolio margining for broad-based index options in July 2005.U.S. futures markets and most European and Asian exchanges for many years have employed risk-based margining similar to CBOE's new rules.

Snip:
The new portfolio margining rules will have the effect of aligning the amount of margin money required to be held in a customer's account to the risk of the portfolio as a whole, calculated through simulating market moves up and down, and accounting for offsets between and among all products held in the account that are highly correlated (for example, options on the S&P 500 Index, "SPX", can be offset against options on the S&P 500 Depositary Receipts, "SPY", or options on DIAMONDS (DIA) can be offset against SPX options). Current practice is to require margin based on set formulas for various strategies (i.e. some spread strategies require a certain minimum margin), regardless of what other offsetting positions were held in the account and regardless of potential market moves. For some positions the margin requirements may not change significantly, but for other positions, such as owning a protective put against a long stock position, the difference may be sizable. This is appropriate in that the margin calculation accounts for the fact that the risk of one position (long stock) is offset by the other (long put).

This will make a huge difference to the margin requirements of certain option positions as some of the examples in this document shows:

COVERED WRITE

Position
Long 500 IBM @ $91.25
Short 5 calls IBM APR 95 @ $ 2.78
Strategy margin is 50% of stock less the short option premium or $21,422.50
Portfolio margin requirement is $5,504.00

PROTECTIVE PUT

Position
Long 500 IBM @ $91.25
Long 5 puts IBM APR 90 @ $ 2.50
Strategy margin is 50% of stock plus full payment for put or $24,062.50
Portfolio margin requirement is $1,878.00

NON-CONFORMING DEBIT SPREAD

(Long must expire on or after short)
Position
Long 50 calls IBM APR 90 @ $5.45
Short 50 calls IBM JUL 100 @ $2.28
Strategy margin requires full payment for long option and
appropriate margin on short option position or $74,750.00
Portfolio margin requirement is $14,106.00

Not mentioned in the examples is a comparison of the collar under the current and new rules. Without pulling out my calculator, it's obvious that the collar margin will be competitive with the debit spread margin. Harking back to The Great Collar Vs Vertical Debate, this might just tip the balance in favour of collars.

It is a marginal advantage, but at least if the underlying tanks on you won't lose the cost of carry on the long call.

The new rules are long overdue and will certainly be welcomed.

Counting My Chickens

Those of us who like to try and trade normal wave structure (whatever that is) must be feeling as if said wave structure had been cancelled indefinately... at least as far as the stock indicies are concerned.

We've all stared disbelievingly at the SP500 for several months now so no need for me to post a chart, but just in case you've been visiting Venus or somewhere over the last months, it's gone pretty much straight up without a breather.

I like to write premium over the indicies in the form of strangles/condors and suchlike and leg into them off what I think may be swing points. More recently, because of the pathetic volatility and relentless boomage, I've tried to have a mixed gamma position in the form of put backspreads written at a credit (My thinking was to position for a correction but still profit if it just kept going up). This has worked pretty well, if not unspectacularly, but at some stage I want to get back to short gamma again...

...and I've done that this expiry. So far the momentum in the SP looks to be slowly abating and looking a tad toppy, to me at least. This first trading day had me thinking I'd have to defend the short calls... then.... a selloff! OMG!

Could this be the start of a long overdue correction? (in the normal wave structure style?). The Dow is still green as I'm typing this but the other indicies are red after being up quite strongly.

I might be counting my chickens, but I think the top is in for this expiry. It will make a nice start for this year if this short gamma position goes out with a whimper.

My $0.02

The Great Vertical vs. Collar Debate

Actually, it was more of an argument than a debate...

Actually, is was more like WW3 lol. In any case, it was an episode in which a whole bunch of option traders and ersatz experts behaved very badly and it centered around the synthetic relationship between a bull call spread and a stock collar. Luckily, there was an occasional snippet of options theory plus the odd piece of mathematics which tied all the acrimony around the central theme.

For those unfamiliar with the terms, a "bull call spread" is a spread composed of one long call, plus a short call of a higher strike. This is a limited risk, limited reward strategy; the payoff diagram of which looks something like this:


A stock collar is a position of long stock, a long put plus a short call. The interesting thing is that the payoff diagram at expiry of the options is similar the the one above.

Now a quick lesson in synthetics. A synthetic position is one which duplicates the risk profile of a natural position. So in our example above, the bull call spread can be viewed as the natural position. The stock collar, if the strikes prices are the same, can be viewed as a "synthetic" bull call spread, since the risk profile is identical. Both positions, if initiated at the same time, and held till expiry will have the same risk and the same reward. There are some non transparent and subtle differences between these two strategies which we'll get into in a minute.

The argument started when one group, lets call them "group O" made a case for collars being superior to verticals (i.e. bull call spreads) in all cases. viz:

The risk graph of a collar and bull call spread are the same, but that is where the similarities end.
You have a much better chance of making money over the long run with collars than bull call spreads because you are always in the position and the stock acts as a flotation device by which you remain at equilibrium.

The problem with a call spread (which is not like the collar) is that if you purchase an OTM call spread the stock can go up and you still lose money if the stock does not appreciate beyond the b/e point. Then when the options expire, you have to put on a new vertical call spread. Because of the run up in the stock which you may not have capitalized on, you will likely have to pay much more for the same vertical spread out the next month or move up a strike. If this keeps happening on a slowly drifting higher stock you could be chasing profits all the time without actualizing any. It is a non-fluid trade because of the starting and stopping effect of moving options around every month.

COLLAR FIXES THIS:
The collar is superior to the vertical because you will be in the stock at all times and do not run into the static fluctuations inherent in an option only strategy. Yes, you have options in the form of a short call and long put, but that is what you want with regard to the horizontal lines of the PNL or Risk Graph of this trade. It is the horizontal line of the stock with the collar that flows while the horizontal line on a vertical has to be moved every month which can disrupt profitability.

Conclusion:
Though the profit and loss graphs of a vertical spread look the same in any given month, they are drastically different when you compare spreads v. collars over several months (or longer). It is for this reason that I think the collar is a greatly superior trade than a vertical. It is why guys who are poor at picking market direction can make a fortune trading collars but have a more hit-or-miss track record with verticals. This is an important distinction!

The opposing group, let's call them group E, thought this was nonsense. Whether it is or not might require another 5o pages of WW4 to sort out lol.

However, having survived the conflagration, which spanned several bulletin boards and many countries, I have come to the following conclusions:

*Any talk of difference in the two strategies in rolling the short strike is nonsense, they are the SAME call. We can effectively strip away the short strike and this leaves us with a natural call and a synthetic call (long stock/long put) for the true comparison.

*There is a difference here in that we pay the cost of carry up front when we buy the natural, whereas the cost carry is "pay as you go" for the synthetic.

*So if the underlying takes a big hit early in the life of the strategy, we cop the additional loss of the cost of carry on the natural.

*"Dividends, capital returns and these types of situations can be detrimental with a bull call spread where the short call is at risk of assignment. The long call will not hedge the div if one is assigned on the short call the day before x-div, so that in itself can create a big difference in the profit/loss between the two strategies if the bull call is not managed properly under these types of conditions." (kudos to "sails")

*"As the interest component is usually around the risk free rate and margin lending is well above the risk free rate, There is an advantage to leverage at a lower interest rate." (kudos again to "sails")

Conclusion (so far): Neither is superior at inception. Obviously if you already hold the stock and you want that sort of risk profile, a collar is a shoe in. If not already holding stock, I personally would go for the bull call spread (if I wanted that risk profile)

Ultimately, the differences lie in the nuances in extreme circumstances, otherwise they are virtually equivalent. As we cannot predict extreme circumstances, the superior strategy for any given extreme, can only be decided in retrospect. My view is either strategy can be used with equal success. Some still don't see it that way.

Result: an uneasy truce. :)