Saturday, February 28, 2009

Paul Volcker's Speech In Toronto

Paul Volcker gave this speech on February 11 in Toronto about the state of the current economic crisis, its causes, and where we are heading. As usual, he makes very good points. You may read it for yourself below.

I really feel a sense of profound disappointment coming up here. We are having a great financial problem around the world. And finance doesn't work without some sense of trust and confidence and people meaning what they say. You take their oral word and their written word as a sign that their intentions will be carried out.
The letter of invitation I had to this affair indicated that there would be about 40 people here, people with whom I could have an intimate conversation. So I feel a bit betrayed this evening. Forty has swelled to I don't know how many, and I don't know how intimate our conversation can be. But I will, at the very least, be informal.

There is a certain interest in what's going on in the financial world. And I will disappoint you by saying I don't know all the answers. But I know something about the problem. Let me just sketch it out a little bit and suggest where we may be going. There is a lot of talk about how we get out of this, but I think it's worth remembering, or analyzing, how this all started.

This is not an ordinary recession. I have never, in my lifetime, seen a financial problem of this sort. It has the makings of something much more serious than an ordinary recession where you go down for a while and then you bounce up and it's partly a monetary – but a self-correcting – phenomenon. The ordinary recession does not bring into question the stability and the solidity of the whole financial system. Why is it that this is so much more profound a crisis? I'm not saying it's going to get anywhere as serious as the Great Depression, but that was not an ordinary business cycle either.

This phenomenon can be traced back at least five or six years. We had, at that time, a major underlying imbalance in the world economy. The American proclivity to consume was in full force. Our consumption rate was about 5% higher, relative to our GNP or what our production normally is. Our spending – consumption, investment, government — was running about 5% or more above our production, even though we were more or less at full employment.

You had the opposite in China and Asia, generally, where the Chinese were consuming maybe 40% of their GNP – we consumed 70% of our GNP. They had a lot of surplus dollars because they had a lot of exports. Their exports were feeding our consumption and they were financing it very nicely with very cheap money. That was a very convenient but unsustainable situation. The money was so easy, funds were so easily available that there was, in effect, a kind of incentive to finding ways to spend it.

When we finished with the ordinary ways of spending it – with the help of our new profession of financial engineering – we developed ways of making weaker and weaker mortgages. The biggest investment in the economy was residential housing. And we developed a technique of manufacturing class D mortgages but putting them in packages which the financial engineers said were class A.

So there was an enormous incentive to take advantage of this bit of arbitrage – cheap money, poor mortgages but saleable mortgages. A lot of people made money through this process. I won't go over all the details, but you had then a normal business cycle on top of it. It was a period of enthusiasm. Everybody was feeling exuberant. They wanted to invest and spend.

You had a bubble first in the stock market and then in the housing market. You had a big increase in housing prices in the United States, held up by these new mortgages. It was true in other countries as well, but particularly in the United States. It was all fine for a while, but of course, eventually, the house prices levelled off and began going down. At some point people began getting nervous and the whole process stopped because they realized these mortgages were no good.

You might ask how it went on as long as it did. The grading agencies didn't do their job and the banks didn't do their job and the accountants went haywire. I have my own take on this. There were two things that were particularly contributory and very simple. Compensation practices had gotten totally out of hand and spurred financial people to aim for a lot of short-term money without worrying about the eventual consequences. And then there was this obscure financial engineering that none of them understood, but all their mathematical experts were telling them to trust. These two things carried us over the brink.

One of the saddest days of my life was when my grandson – and he's a particularly brilliant grandson – went to college. He was good at mathematics. And after he had been at college for a year or two I asked him what he wanted to do when he grew up. He said, "I want to be a financial engineer." My heart sank. Why was he going to waste his life on this profession?

A year or so ago, my daughter had seen something in the paper, some disparaging remarks I had made about financial engineering. She sent it to my grandson, who normally didn't communicate with me very much. He sent me an email, "Grandpa, don't blame it on us! We were just following the orders we were getting from our bosses." The only thing I could do was send him back an email, "I will not accept the Nuremberg excuse."

There was so much opaqueness, so many complications and misunderstandings involved in very complex financial engineering by people who, in my opinion, did not know financial markets. They knew mathematics. They thought financial markets obeyed mathematical laws. They have found out differently now. You know, they all said these events only happen once every hundred years. But we have "once every hundred years" events happening every year or two, which tells me something is the matter with the analysis.

So I think we have a problem which is not an ordinary business cycle problem. It is much more difficult to get out of and it has shaken the foundations of our financial institutions. The system is broken. I'm not going to linger over what to do about it. It is very difficult. It is going to take a lot of money and a lot of losses in the banking system. It is not unique to the United States. It is probably worse in the UK and it is just about as bad in Europe and it has infected other economies as well. Canada is relatively less infected, for reasons that are consistent with the direction in which I think the financial markets and financial institutions should go.

So I'll jump over the short-term process, which is how we get out of the mess, and consider what we should be aiming for when we get out of the mess. That, in turn, might help instruct the kind of action we should be taking in the interim to get out of it.

In the United States, in the UK, as well – and potentially elsewhere – things are partly being held together by totally extraordinary actions by a central bank. In the United States, it's the Federal Reserve, in London, the Bank of England. They are providing direct credit to markets in massive volume, in a way that contradicts all the traditions and laws that have governed central banking behaviour for a hundred years.

So what are we aiming for? I mention this because I recently chaired a report on this. It was part of the so-called Group of 30, which has got some attention. It's a long and rather turgid report but let me simplify what the conclusion is, which I will state more boldly than the report itself does.

In the future, we are going to need a financial system which is not going to be so prone to crisis and certainly will not be prone to the severity of a crisis of this sort. Financial systems always fluctuate and go up and down and have crises, but let's not have a big crisis that undermines the whole economy. And if that's the kind of financial system we want and should have, it's going to be different from the financial system that has developed in the last 20 years.

What do I mean by different? I think a primary characteristic of the system ought to be a strong, traditional, commercial banking-type system. Probably we ought to have some very large institutions – or at least that's the way the market is going – whose primary purpose is a kind of fiduciary responsibility to service consumers, individuals, businesses and governments by providing outlets for their money and by providing credit. They ought to be the core of the credit and financial system.

This kind of system was in place in the United States thirty years ago and is still in place in Canada, and may have provided support for the Canadian system during this particularly difficult time. I'm not arguing that you need an oligopoly to the extent you have one in Canada, but you do know by experience that these big commercial banking institutions will be protected by the government, de facto. No government has been willing to permit these institutions, or the creditors and depositors to these institutions, to be damaged. They recognize that the damage to the economy would be too great.

What has happened recently just underscores that. And I think we're at the point where we can no longer fool ourselves by saying that is not the case. The government will support these institutions, which in turn implies a closer supervision and regulation of those institutions, a more effective regulation than we've had, at least in the United States, in the recent past. And that may involve a lot of different agencies and so forth. I won't get into that.

But I think it does say that those institutions should not engage in highly risky entrepreneurial activity. That's not their job because it brings into question the stability of the institution. They may make a lot of money and they may have a lot of fun, in the short run. It may encourage pursuit of a profit in the short run. But it is not consistent with the stability that those institutions should be about. It's not consistent at all with avoiding conflict of interest.

These institutions that have arisen in the United States and the UK that combine hedge funds, equity funds, large proprietary trading with commercial banks, have enormous conflicts of interest. And I think the conflicts of interest contribute to their instability. So I would say let's get rid of that. Let's have big and small commercial banks and protect them – it's the service part of the financial system.

And then we have the other part, which I'll call the capital market system, which by and large isn't directly dealing with customers. They're dealing with each other. They're trading. They're about hedge funds and equity funds. And they have a function in providing fluid markets and innovating and providing some flexibility, and I don't think they need to be so highly regulated. They're not at the core of the system, unless they get really big. If they get really big then you have to regulate them, too. But I don't think we need to have close regulation of every peewee hedge fund in the world.

So you have this bifurcated – in a sense – financial system that implies a lot about regulation and national governments. If you're going to have an open system, you have got to get much more cooperation and coordination from different countries. I think that's possible, given what we're going through. You've got to do something about the infrastructure of the system and you have to worry about the credit rating agencies.

These banks were relying on credit rating agencies while putting these big packages of securities together and selling them. They had practically – they would never admit this – given up credit departments in their own institutions that were sophisticated and well-developed. That was a cost centre – why do we need it, they thought. Obviously that hasn't worked out very well.

We have to look at the accounting system. We have to look at the system for dealing with derivatives and how they're settled. So there are a lot of systemic issues. The main point I'm making is that we want to emerge from this with a more stable system. It will be less exciting for many people, but it will not warrant – I don't think the present system does, either — $50 million dollar paydays in that central part of the system. Or even $25 or $100 million dollar paydays. If somebody can go out and gamble and make that money, okay. But don't gamble with the public's money. And that's an important distinction.

It's interesting that what I'm arguing for looks more like the Canadian system than the American system. When we delivered this report in a press conference, people said, "Oh you mean, banks won't be able to have hedge funds? What are you talking about?" That same day, Citigroup announced, "We want to get rid of all that stuff. We now realize it was a mistake. We want to go back to our roots and be a real commercial bank." I don't know whether they'll do that or not. But the fact that one of the leading proponents of the other system basically said, "We give up. It's not the right system," is interesting.

So let me just leave it at that. We've got more than 40 people here but they're permitted to ask questions, is that the deal?

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Friday, February 27, 2009

Stay Away from 2X ETFs, Cause and Effect Relationships

Here are the total daily dollar amounts traded as of yesterday in the financial 2X and 3X ETFs:

SKF: $5.1B
FZA: $1.3B

XLF: $2.0B

The volume on UYG ($370M) and FAS ($800M) is small or negligible compared to these.

The SKF and FZA issuers must hedge themselves by shorting stock or using other instruments like CDS. They absolutely have to do it or risk going bankrupt. The effects are obvious on the underlying stock prices.

When those SKF holders start stampeding out, watch out above. All the shorting must be covered. You may see the mother of all rallies.

For similar cause-effect reasons to the downside, it is possible that these 2X derivatives to be outlawed. In fact, a great rally would occur by doing so, except for the ETFs themselves which would drop to $0.

Buying these is like playing with fire. Fire can burn and hurt badly!

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Don't Buy USO or USL, Buy UGA Instead

We have explained in recent posts the many issues with USO and USL (re. rolling of oil contracts). Gasoline prices in the USA and Canada have recovered during the last few weeks, as you may have seen at the pumps. The prices for gasoline you are paying now has not dropped recently, it likely has gone up.

U.S. unleaded gasoline prices has usually seasonal strength from January to the end of April. During this time refiners tend to convert from heating oil used in winter to gasoline used during the summer. Refiners also use this period to perform annual maintenance programs. Gasoline consumption goes up while inventories usually go down. This is why gasoline prices rise during this period, typically this trend lasts until May for retail prices.

In the USA, demand for gasoline is still higher in spite of the recession in the economy. A good chunk of U.S. refineries is old and need to undergo significant maintenance and repairs. If you remember, the hurricane season last year also was quite violent with many hurricanes entering the Gulf of Mexico and causing significant damage to oil and gas installations. Remember Fay, Gustav, Hanna, Ike,, Josephine, Kyle?

In addition, the spread between crude oil and refined product prices ("crack spreads") were below average late in 2008 and have not recovered much in 2009.

If you agree that gasoline prices will outperform oil, then UGA is a better investment vehicle. UGA invests in future gasoline contracts:

"United States Gasoline Fund is an exchange traded security that is designed
to track in percentage terms the movements of gasoline prices. UGA issues units
that may be purchased and sold on the New York Stock Exchange (NYSE) Arca. The
Fund is managed and controlled by its general partner, United States Commodity
Funds LLC. USG pays the General Partner a management fee of 0.60% of net asset
value (NAV) on its average net assets. USG invests in a mixture of listed
gasoline futures contracts, other non-listed gasoline related investments,
Treasuries, cash and cash equivalents. "

Below is a chart comparing USO, USL, and UGA for the last 3 months. Clearly, UGA is the top performer of the three.

(please click to enlarge)

Keep in mind that UGA is a cousin of USO/USL and may suffer from same rollover issues, but at least it offers better odds for someone who wishes to invest in this area.

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Thursday, February 26, 2009

UCO Straddles: Proof of Concept

The UCO 5-7.50 and 6-6- straddles I have been posting are already profitable today, in spite of the move having been only a fraction of the maximum move required. As discussed, this is because there are still many days to options expiration (see our new gadget on the top right corner).

The March 6 calls are worth $2+ (bought for $0.90), the March 7.50 calls are trading for $1 (bought for $0.40-$0.50). The March 6 puts still worth $0.20.

And UCO is still rising.

This is from late February:

More straddles will be uploaded later.

Readers know my position on 2X and 3X ETFs. I recommend nobody should buy UCO straight. Use straddles, beat them at their own game.

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Mitsubishi Shifts Production from Japan to Brazil, Itau Reports


Japanese auto giant Mitsubishi will shift some of its production to Brazil. The move is in part to mitigate the effects of the higher Japanese Yen, according to the Nikkei newspaper. Mitsubishi's objective is to install in Brazil its base for exports in all of Latin-America. Another reason is to take advantage of special tax and duties that are in effect between Brazil and the rest of Latin-America.

The company also intends to increase production in Brazil.


In banking news, Itau/Unibanco reported today, symbol ITU on the NYSE. Net profits were R$7.8B. This includes provision sof R$3.0B for bad loans. Without this provision, the net profits would have been R$10.6B, an increase of 9.1% over the previous tear.

ITU shares dropped 3.4% today.

These numbers would certainly be the envy of many banks in North-America!

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Wednesday, February 25, 2009

Unemployment in the USA From 2007 to 2009

Here is a chart of the monthly job growth in the US since 2007.

A picture is worth a thousand words!

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Job Market for 2009

I received this funny video which shows the prospects of the job market in 2009 for Wall St. types. How to find a job? Look for the Mexican farmer.

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Monday, February 23, 2009

Protect Yourself: Straddles for March

The market today broke the S&P 500 was trading around 750. Technical analysts say that, if confirmed, this a major support that has been broken (755), and a major downtrend is possible.

Whether this analysis is correct or not, investors can protect themselves by using straddles. With straddles it does not matter if the government annoucnes a mahor deal that will save the banks and the market rallies, or if they banks will be nationalized and the market plunges. It also does not matter if the market is rigged and is manipulated to the upside or to the downside.

IWM is a favorite vehicle for straddles because of its liquidity and narrow bid-ask spreads. Here are some straddles for March, taken when IWM was trading between $39.96 and $40.10.




Note how the number of calls starts to be quite different from the number of puts to maintain the same $1,000 investment in each branch of the strangle.


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Saturday, February 21, 2009

February Max Pain Update, Demystifying MaxPain

This is an update on Friday's post max pain in practice.

Options expiration day was one of the quietest ever. Stocks dropped all morning and staged a comeback attempt in mid afternoon. In the end, SPY dropped another $1 strike price, finishing in the $77s, enabling another 82,682 puts to become 'in the money', while only 11,881 calls became 'in the money'. IWM finished in the same $41 range where it was the prior day.

Puts activity yesterday:

Calls activity:

Note the huge trading volume (second last column) and the drop in open interest (last column) as the positions were closed.

Overall, max pain appears to have had had no effect this time around. The market makers and option writers collectively missed out on a very large amount of money. The 82+ thousand puts that became in the money were worth roughly $16M. The put writers, however, likely originally sold those puts at higher values much ahead of expiration and it cost them $0.50 to cover them . Based on our previous studies, those were originally sold at somewhere around $2 to $3. They just did not optimize their winnings.

This time around Max Pain was just a myth.

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President Barack Obama Visits Canada

I have posted twice about President Obama's visit to Canada. The President was being anxiously awaited by Canadians and was extremely well-received this past Thursday. Although it was only a short working visit, the President managed to sneak a visit to the local market area here in snowy Ottawa, and mingled with pedestrians, who were more than thrilled.

Here are some pictures of the visit:

This 16-year old him some beavertails:

What are beavertails you may ask? Ah, they are delicious! (and unhealthy!)

And people concerned about the Canadian oil sands:

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Friday, February 20, 2009

Update on USO and March Oil Contracts

Re. USO Beware post, here is what happened by the end of the day yesterday.

March oil contracts finished up 14.04%.
USO finished up only (relatively speaking) 6.21%
UCO (the 2X ETF) finished up only 11.97%

Again, this was due to the rolling over to April contracts. Investors in USO badly missed on the price increase.

Here are the prices as of 10:30AM today. Remember March contracts expire today.

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SPY and IWM Options Action Today, Max Pain in Practice

Max pain numbers for SPY (84) and IWM (48) are significantly higher than the current price of the underlying. The tables below show what will happen for every $1 increase of both IWM and SPY in terms of number of calls that become in-the-money and number of puts that become out of the money, based on the current prices.

Based on these numbers, it is clearly more convenient for the market makers (options sellers), to have IWM and SPY go up today. We shall see what happens by the end of the day.

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Thursday, February 19, 2009

Buyers of USO Beware

Today oil March contracts are up about 8.20%, from $34.62 to $37.70. These contracts expire tomorrow February 20. So what happens today with USO and UCO? Take a look:

USO is up 5.4% The reason is that USO just switched to April contracts.

In the process, by the way, USO sold at the March prices and bought at the April prices. So the same amount of money they had, now own fewer equivalent barrels of oil, about 20% fewer! If oil continues in contango, the same loss will happen in about 4 weeks.

So the poor investors who bought USO got to ride all the losses for the month and today do not rip the rewards.

How about UCO? That is a 2X ETF!

Buyer beware cannot be said loud enough.

Here are the contract calendars (please click to enlarge):

To avoid all these issues (you may have better chances at a casino), you may instead use straddles. We have been doing UCO straddles since UCO was at $12, which was just a few days ago.

Note: these were the 6-6 straddles published yesterday at 9:35AM at

This is currently breaking even, let's see how they do by tomorrow.

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Max Pain for February, Price Convergence Watch

Options expiration is tomorrow Friday. Currently, max pain numbers are significantly higher than the corresponding stock prices. Here are the current max pain values compared to the stock prices:

SPY - Max Pain: 85, current price: 79.03, difference: 7.55%
DIA - Max Pain: 81, current price: 75.76, difference: 6.91%
IWM - Max Pain: 48, current price: 42.29, difference: 13.50%
XLF - Max Pain: 9, current price: 7.97, difference: 12.92%

With the recent significant declines in the stock market, max pain has not been accurate, as in accuracy of predicting the final price on expiration day. However, in general, the max pain value and the current price tend to converge to each other, at least partially, at expiration. If this holds, we would expect to see a sharp drop in max pain values and a rise in share prices.

Of the above, IWM is the most undervalued.

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Wednesday, February 18, 2009

Correlation of the Dow 30 Stocks

Following our post on how the DJIA index is really a Dow 15 index, here is a correlation study of the 30 stocks that compose the index.

1. Considering prices over the last 6 months.

Bright green indicates correlation of over 0.85
Dark green indicates correlation of over 0.75

(please click on image to enlarge)

Note that in the table above (870 points) there are zero negative correlations under -0.10, while there are 291 correlations over 0.75.
XOM is the only negatively correlated stock with any of the others in the entire index. All others have some degree of correlation with each other.

2. Correlations considering 2009 prices only (since January 2).

Similarly, there are 164 correlations over 0.75.

The only stock really with negative correlations to any of the others is IBM. Note that IBM is the only stock to go up in 2009. All other stocks have some degree of correlation with each other, with the exception of MSFT and KFT which had no strong correlations.

AA is positively correlated with 20 other stocks and MCD with 19 others respectively. AA and MCD themsleves have a positive correlation of 0.92! Either of these may be seen as a proxy for the entire index. UFC has positive correlation with 18 others, and a 0.98 (near perfect) correlation with AA.

This chart shows the prices of the DJIA stocks since Jan 2 2009:

(please click to enlarge)


The conclusion is that the DJIA (or the DIA ETF) offers near zero diversification. As we found our previously, the index is also determined by only one half of its stocks (the DOW15), since the other half has fallen in price very heavily and the index is price-weighted.

This is a very dangerous index to invest in, and one that can be easily manipulated or controlled.

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Tuesday, February 17, 2009

UCO Straddles for This Week and March

With earnings season over, we now move back to regular straddles. Prices for new straddles These will be updated a

We have been playing UCO straddles since UCO was over $12, and rolling them over or buying new ones to match the successive new lower prices.

Last' Friday's unthinkable 7.50 straddle is now well in the money and should be sold. To move these lower to 6-7.50 for February is risky and again "unthinkable". However, the unthinkable has happened several times in the last couple of weeks.

Please see move required below, captured with our new StraddlesCalc2 tool.

Just a couple of days ago we were doing this:

The 9 puts are now worth $2.90, while the 9 calls are still worth $0.40, total $3.30, versus cost of $2.75. Note that the move in price of the underlying was 31.5%.

UPDATE 4PM: The 9 puts are now worth $3.10 and the 9 calls $0.35, for a total of $3.45. ROI is +25.4%.

We also posted the 9-10 strangle, which was purchased at a cost of $1.30. Today, had we held this, if would be worth $2.75, for +111.5%. In fact, any of the straddle and straddles so far would be quite profitable had they been held. Instead of holding, it is advisable to take frequent profits and use only profits when you buy new straddles. This market cannot to be trusted.

Always, always do your own due diligence please.

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Sunday, February 15, 2009

Snow Artists, Protectionism, and Obama Visits Canada

President Obama will visit Ottawa this coming Thursday on his first official foreign state visit. We can only hope that the made in USA provisions of the US's latest stimulus package are discussed and - and ultimately avoided. Ever since those protectionist ideas started to appear in the US they have spread to other countries of the world, including Canada. The president of the Canadian Auto Workers Union appeared on TV this week advocating that the Canadian stimulus money be used on Canadian wages! This is the type of attitude that can bring the world to its knees, with all countries shutting their borders to foreign products. The result of these attitude will be disastrous once again for the the world, just like when President Herbert Hoover increased tariffs and protectionism in the 1930s (not to mention bailouts and big spending on public works projects...)

Here's a small description of Hoover, found on the White House web site:

"After capably serving as Secretary of Commerce under Presidents Harding and Coolidge, Hoover became the Republican Presidential nominee in 1928. He said then: "We in America today are nearer to the final triumph over poverty than ever before in the history of any land." His election seemed to ensure prosperity. Yet within months the stock market crashed, and the Nation spiraled downward into depression.

After the crash Hoover announced that while he would keep the Federal budget balanced, he would cut taxes and expand public works spending.

In 1931 repercussions from Europe deepened the crisis, even though the President presented to Congress a program asking for creation of the Reconstruction Finance Corporation to aid business, additional help for farmers facing mortgage foreclosures, banking reform, a loan to states for feeding the unemployed, expansion of public works, and drastic governmental economy."

We can only hope that true leadership will be shown by the elected leaders and that they will have the courage to do what is right.

President Obama will be literally a couple hundred meters from another site of Ottawa's Winterlude, Parc Jacques Cartier, just across the river from Parliament. Here are some pictures and a video.

(please click on images to enlarge)

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Saturday, February 14, 2009

World's Oil Production: Top Consumers and Producers, and The Effects on USO, USL, and UCO

With the recent collapse of the price of oil, OPEC countries have agreed to cut production. Which countries, if any, will actually cut production, and what would the effect be on the price of oil?

First, let's take a look at the top producing countries:

World's top oil producers (as of 2007, in barrels per day):

Saudi Arabia 11,000,000 bbl
Russia 9,870,000 bbl
United States of America 7,460,000 bbl
Iran 3,956,000 bbl
China 3,725,000 bbl
Canada 3,310,000 bbl
Mexico 3,083,000 bbl
Norway 2,560,000 bbl
Venezuela 2,398,000 bbl
Iraq 2,093,000 bbl
Brazil 1,797,000 bbl
Libya 1,712,000 bbl
United Kingdom 1,636,000 bbl
Indonesia 837,500 bbl
India 810,000 bbl
Argentina 730,000 bbl
Egypt 665,000 bbl
Australia 540,000 bbl
Syria 379,000 bbl
Denmark 342,000 bbl
Thailand 310,000 bbl

The question is, of these countries, which ones will actually cut production, and which will not given that they may desperate need to oil revenues. Let us first take a look at the top oil consumers (data from 2005):

United States of America 20,800,000 bbl
China 6,930,000 bbl
Japan 5,353,000 bbl
Russia 2,916,000 bbl
Germany 2,618,000 bbl
India 2,438,000 bbl
Canada 2,290,000 bbl
South Korea 2,130,000 bbl
Brazil 2,100,000 bbl
Mexico 2,078,000 bbl
Saudi Arabia 2,000,000 bbl
France 1,999,000 bbl
United Kingdom 1,820,000 bbl
Italy 1,732,000 bbl
Iran 1,630,000 bbl
Spain 1,600,000 bbl
Indonesia 1,100,000 bbl
Thailand 929,000 bbl
Australia 903,200 bbl
Taiwan 816,700 bbl
Turkey 660,800 bbl
Egypt 635,000 bbl
Venezuela 599,000 bbl
South Africa 519,000 bbl
Argentina 480,000 bbl

And here is the the net between production and consumption:

(please click on image to enlarge)

From the list, we can see that Saudi Arabia that is pretty much the only country with significant exports that has the luxury of allowing itself to cut production. Russia desperately needs the revenue, so does Venezuela and several of the other top net exporters.. The US, China, do not export. The US is dead last on this list.

In 2007 Saudi Arabia was responsible for around 17% of the world production of 60.1M barrels per day, for 30% of the net exports of 28.2M barrels per day.

So, when OPEC says they will cut production, will they? How much will the actual reduction be, and how will it affect the price of oil? Given that oil consumption is unlikely to pick up due to the current economic crisis, the answer to this question may can be used to reach conclusions on what will the price of USO, USL, UCO do in the near future. It does not look too good for 2009, regardless of stated production cuts.

You may download this file here in Excel format.

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Friday, February 13, 2009

Updated UCO and USO Straddles

UCO is approaching $7.50 again. Below you will find updated straddles and strangles for February, March and April. Note that UCO Feb. requires a move of 15%, which does not take long lately.

Note also that oil is higher today, but UCO is lower. With straddles you don't care which way the stock goes, or whether they track what they are supposed to track or not.

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Thursday, February 12, 2009

Results for UCO, USO, UNG Straddles

Below is a table showing the results of the UCO straddles, as well as USO and UNG for comparison.

The UCO 7.50-10 strangle returned 32% since this morning.

(Please click on image to enlarge.)

This what UCO did in the last 3 days, a drop of approximately 24%. Of course the advantage the straddles is that the profits would also have been achieved if oil had moved to the upside as well, (and you get to sleep well at night):

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Wednesday, February 11, 2009

Straddles for Oil and Natural Gas, USO, UCO, UNG

Here are upcoming straddles and strangles for February and March for oil and natural gas. The last column shows the maximum move required. These are obtained with our straddles calculator tool and tracking will be added to

USO, UCO, and UNG:

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Oil Consumption To Drop to Lowest Levels in 27 Years

Related to our post on USO versus USL two days ago, the International Energy Agency has just released its February forecast which confirms the lower demands expected for 2009.

  • 2009 oil demand forecast fell by 570 kb/d to 84.7 mb/d (million barrels per day). This is 1 mb/d less than in 2008, the biggest drop in 27 years.
  • January 2009 oil supply fell by 520kb/d 85.2 mb/d.
  • OPEC supply fell in January by 920 kb/d to 29 mb/d
  • Q4 2008 storage increased by 170 kb/d due to low refiner runs
  • Floating storage is between 50 to 80 mb.

The IEA Expects world consumption to drop to 2006 levels and USA consumption to drop to 1998 levels, or 19 mb/d (2.8% less than in 2008). China oil consumption growth was revised down by only 30 kb/d, for a growth of 0.7%.

Latest oil consumption and supply charts:

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Monday, February 9, 2009

Straddles for February 9 and 10

Here are some of the interesting straddles for Feb 9 and 10. You can track them live.

Feb 9:

Feb 10:

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The Tale of USO, USL and Contango.

Investors have been piling into the USO ETF expecting to profit from a future increase in oil prices. However, would you invest in a financial-derivative instrument that declines when the underlying remains constant?

Because of contango (further out oil contracts being more expensive than near term contracts) that is exactly what has been happening with USL in the recent months. USO invests in near term contracts, currently $40.72 for March contracts. In one month, USO will be forced to switch to April contracts, which are more expensive and now trade around $46.66. Thus USO, will hold fewer equivalent barrels of oil. If the price of oil remains constant, a month later, USO will be worth 12.7% less (=$40.72/$46.66), just before it moves to May contracts, and the whole process repeats itself, holding fewer and fewer equivalent barrels of oil.

Here are the current prices as per Nymex:

A better investment is USL, which spreads its investments into 12 months of future contracts. USL will still suffer from the contango effect though, with higher losses in the front-end months (where USO takes its big hit), and smaller losses in the back-end months. Below are some comparisons between the two.

5 days USL vs USO comparison:

1 month comparison:

3 months:

6 months:


Clearly USL has performed better than USO in all timeframes, but it will also be affected by contango. If the price of 0il will remain constant, you should really invest in neither of them. This is another case of buyer-beware.

About USO: The USO, United States Oil Fund, is a domestic exchange traded security designed to track the movements of light, sweet crude oil (West Texas Intermediate). "USO issues units that may be purchased and sold on the New York Stock Exchange (NYSE) Arca. The Company invests in futures contracts for light, sweet crude oil and other types of crude oil, heating oil, gasoline, natural gas and other petroleum-based fuels that are traded on the New York Mercantile Exchange (NYMEX), International Currency Exchange (ICE) Futures or other United States and foreign exchanges (collectively, Oil Futures Contracts)"

About USL: The USL, United States 12 Month Oil Fund, LP (US12OF) is an exchange traded security that is designed to track the movements of West Texas Intermediate light, sweet crude oil (WTI). "USL issues units that may be purchased and sold on the New York Stock Exchange (NYSE) Arca. The investment objective of US12OF is to have the changes in percentage terms of the units net asset value reflect the changes in percentage terms of the price of light, sweet crude oil delivered to Cushing, Oklahoma".

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AKAM, AMZN and WY Straddles Analysis

There were some very significant straddle winners in the last 2 weeks. Below you will see some charts that tell the stories.

AMZN (Amazon):

(please click to enlarge)

AKAM (Akamai):

WY (Weyerhaeuser):

This one was bought on Thursday and sold on Friday. As expected, WY reported very large losses. The stock tanked quite significantly initially. The 25 puts, which were bought at $0.50, reached as high as $1.23. Unfortunately I did not sell the puts at that point. I was expecting WY to continue dropping s its results were so bad. The company had an earnings conference call in the middle of the morning, and that caused the stock to recover somewhat. I ended up selling them at $0.75, a 50% gain over the cost of the puts. However, the 30 calls were sold at an 80% loss, so overall the play returned a loss of about 10% (the play was about 3:2 in favor of the puts as we heavily expected a drop in the stock price). Bottom line is to stick to a predefined exit profit strategy.

Incidentally, note below what a investor did on the 25 puts, having bought over 2,000 contracts. A similar pattern happened with AKAM 15 calls.

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