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The markets continue to be highly volatile and unstable. This is a prime condition for straddles.
Here are July straddles and strangles for financials, Russel 2000, oil, and gold, via the ETFs XLF, IWM, UCO, and GLD (click on each symbol to receive buy/sell alerts)
(please click to enlarge)
Note that options are very dangerous and may cause 100% loss. This is not advice. Please do your own due diligence.
Dennis Lockhart, President of the Federal Reserve Bank of Atlanta made the most downbeat statement on the U.S. economy from a Fed official in recent months. He said today that the U.S. economic recovery is not sustainable to either raise interest rates or shrinking the central bank’s near-record balance sheet.
According to Bloomberg, he says that there is a “small risk of deflation,” and the "rebound from the worst recession since the 1930s faces risks from Europe’s debt crisis, drops in state and local spending, commercial real estate losses and the Gulf of Mexico oil spill".
“Recent developments make me even more convinced that current policy is appropriate,” “Financial markets and many businesses are more nervous today than a few weeks and months ago, and it’s my view that monetary policymakers should hold to a guarded policy stance and evaluate carefully the risk and reward of a change of policy.”
“The economy has not yet arrived at a state where healthy and sustainable final demand is underpinning growth,” “I make this point not to predict a reversal of the progress made but just as a cautionary reminder to avoid counting chickens too early.”
Mr. Lockhart does not vote on the FOMC (Federal Open Market Committee) this year.
While U.S. financial firms have “rather small and manageable direct exposure to the Greek government” and other European sovereign borrowers, there’s still a risk that financial market pressures may be transmitted to the U.S. economy and that a stronger dollar may weaken demand for exports".
“This situation is our nation’s very immediate analog of the public finance pressures being felt in Europe,”
As for commercial real estate, small and regional banks, Lockhart says that “face a heavy docket of loan restructurings that may require sizable write-downs,” “Views vary on how severe a problem is developing and whether it will require an organized comprehensive resolution effort to avoid widespread damage to the economy.”
Mike Shedlock (Mish) was pretty clear this morning. The issue at stake (this week) is that the ECB appears to be indeed ending is E442B bank lending program, as we reported on the weekend.
"Spain and Greece Will Both Default. It should be perfectly obvious that at some point Spain and Greece are going to default. The factors at play are ...
INO has a new video showing that currently there are negative engulfing lines for the Nasdaq and S&p500. This is very bearish for the markets. The video explains (watch video or run the tool on any stock (risk free)
The Economist has an excellent article on the use of debt by countries - and citizens - today. The article begins:
MAN is born free but is everywhere in debt.
The answer to all problems seemed to be more debt. Depressed? Use your credit
card for a shopping spree “because you’re worth it”. Want to get rich quick?
Work for a private-equity or hedge-fund firm, using borrowed money to enhance
returns. Looking for faster growth for your company? Borrow money and make an acquisition. And if the economy is in recession, let the government go into
deficit to bolster spending....
Rising government debt is a Ponzi scheme that requires an ever-growing population to assume the burden—unless some deus ex machina, such as a technological breakthrough, can boost growth.
...
If the Western world faces an era of austerity as debts are paid down, how will that affect day-to-day life? Clearly a society built on consumption will have to pay more attention to saving. The idea that using borrowed money to buy assets is the smart road to riches might lose currency, changing attitudes to home ownership as well as to parts of the finance sector such as private equity.
That recessions are quite common while depressions are rare is well known. Paul Krugman’s latest column in The New York Times says that as far as he can tell, there were only two eras in economic history that were widely described as “depressions”:
In opposite camps to what Tim Geithner has been saying, the Bank for International Settlements has just released its annual report. The bank acts like the central bank of central banks. Its annula general meeting was attended by all the heavy weights of globla finances, including ECB President Jean-Claude Trichet, Ben Bernanke, and Bundesbank President Axel Weber.
If course, most other countries want other countries's stimulus to continue, as they will then articially stimulate their economy and they have places to export to.
However, the BIS warns that keeping interest rates too low for too long alters investment decisions. and that the direct central bank participation “entails significant risks.”
The report adds: “The time has come to ask when and how these powerful measures can be phased out,” “The cumulating side effects themselves pose a danger that, at the very least, implies exiting sooner than may be comfortable for many.”
"The financial crisis has left policymakers with a daunting legacy, especially in industrial countries. In setting policies, they must adopt a medium- to longterm perspective while they cope with the still fragile and uneven recovery. Households have only just begun to reduce their indebtedness and therefore continue to curb spending. Extraordinary support measures helped to contain contagion across markets, preventing the worst. But some measures have delayed the needed adjustments in the real economy and financial sector, where the reduction of leverage and balance sheet repair are far from complete. All this continues to weigh on confidence. The combination of remaining vulnerabilities in the financial system and the side effects of ongoing intensive care threaten to send the patient into relapse and to undermine reform efforts.
Macroeconomic support has its limits. Recent market reactions demonstrate that the limits to fiscal stimulus have been reached in a number of countries. Immediate, front-loaded fiscal consolidation is required in several industrial countries. Such policies need to be accompanied by structural reforms to facilitate growth and ensure long-term fiscal sustainability. In monetary policy, despite the fragility of the macroeconomy and low core inflation in the major advanced economies, it is important to bear in mind that keeping interest rates near zero for too long, with abundant liquidity, leads to distortions and creates risks for financial and monetary stability.
Fundamental reform of the financial system must be completed to put it on more stable foundations that would support high sustainable growth for the future. Above all, reform should produce more effective regulatory and supervisory policies as part of an integrated policy framework. A new global framework for financial stability should bring together contributions from regulatory, supervisory and macroeconomic policies. Supported by strong governance arrangements and international cooperation, such a framework would promote the combined goals of financial and macroeconomic stability".
Brazil's Agencia Estado reports that at the G20 meeting in Toronto, Cristina Kirchner, Argentina's President, said she favors maintaining the stimulus to economic activity in Europe. In her speech at the summit, Cristina argued that the economic policies of fiscal adjustment envisaged by the EU may "deepen the crisis in the region and these countries will end up like Argentina, 2001,"
In 2001 Argentina decreed the largest debt default sovereign in history, more than $140B, after several tough fiscal squeezes. At the Mercosur-EU meeting last month in Madrid, Argentinean gave similar advice to the Head of the Spanish government Jose Luis Zapatero on how to tackle the crisis.
During her participation in the second world congress of the International Trade Union Confederation, in Vancouver, Cristina hit the same button. "We must sustain the counter-cyclical measures because these adjustment policies will worsen these situations,"
She asked to "take Argentina from 2001 as an example." "Many countries in the eurozone today apply the same policies that led Argentina to the disaster,"
However, stimulus policies have a high price. The Argentine president did not present any remedy for the high inflation in the country, which has already accumulated a high of 25% for the past 12 months and may reach 30% by the end of the year. It is the highest rate among the G-20. To the government, however, official inflation is 10%.
In recent months the news has been all about Europe and how European countries need to cut their deficits. However, the day is coming very soon when U.SD. states will have to act as their problems are similar.
Bloomberg has a nice summary on the states' dire straits. California's unemployment was 12.4% in May, that is 2.7% higher than the national rate. The budget gap is $19B. The solutions are to end main welfare program for 1.3 million families or the borrowing more than $9B in the bond market.
Neither will do any good to the "economic recovery".
"California, tied with Illinois for the lowest credit rating of any state, is diverting a rising portion of tax revenue to service debt, Bloomberg Markets magazine reports in its August issue.Far from rebounding, the Golden State, with a $1.8 trillion economy that’s larger than Russia’s, is sinking deeper into its financial funk. And it’s not alone".
Finances in Arizona, Illinois, New Jersey, New York and other states are in similar situations.
"Forty-six states face budget shortfalls that add up to $112 billion for the fiscal year ending next June, according to the Center on Budget and Policy Priorities, a Washington research institution. State spending is 12 percent of U.S. GDP."
“States are going to have to cut back spending and raise taxes the same way Greece and Spain are,” says Dean Baker, co- director of the Center for Economic and Policy Research in Washington. “That runs counter to stimulating the economy and will put a big damper on the recovery in the latter half of this year.”
New Jersey Governor Christine Todd Whitman: “States don’t have a choice anymore,” “These problems are going to require major surgery.”
Trading Econonomics sends out regular updates concerning upcoming global news for the financial markets. For this week most of the medi'as focus will be on unemployment news in the U.S., however, there is potential for bad news in Europe:
Apple's (AAPL) new iPhone4 was launched with the usual Apple marketing blitz and Apple fans went nuts to buy one. However, it was not long afterwards that problem started being reported. it appears there are significant reception problems and they are due t the way people hold the phones. Their hands block reception. Some are suggesting an iGlove to solve the problem.
An explanation comes from AntennaSys a company that has expertise in antenna design. This is their explanation, (typos corrected) in which they appear to blame the FCC (!). Obviously it is not the FCC's responsibility for the iPhone's flaws, but the article explains the technicalities:
"The FCC puts strict limits on the amount of energy from a handheld device that may be absorbed by the body. We call this Specific Absorption Rate, or SAR. In the olden days, when I walked ten miles to school in three feet of snow, uphill in both directions, cell phones had pull-up antennas. This allowed the designer to use a half-wave antenna variant, and put the point of maximum radiation somewhat away from the user’s cranium. Of course, most people did not think it was necessary and kept the antenna stowed. Motorola’s flip phone acutely had a second helical antenna that was switched into place when this was the case. But, more importantly, SAR rules were not yet in effect.
Flip phones became yesterday’s style, and phones were becoming more monolithic. Some phones, like the early Treo, kept the antenna in the traditional location at the top of the phone, near one edge, but reduced it to a short stub. Whips became stubs, stubs became bumps, and finally antennas were embedded into the rectangular volume of the phone. The trouble was SAR; if you left the antenna at the top, the user was now pressing it into their head, insuring lots of tissue heating. Enter the bottom-located cellphone antenna.
Just about every cell phone in current production has the antenna located at the bottom. This insures that the radiating portion of the antenna is furthest from the head. Apple was not the first to locate the antenna on the bottom, and certainly won’t be the last. The problem is that humans have their hands below their ears, so the most natural position for the hand is covering the antenna".
The rest goes on blaming the FCC, which is ludicrous.
Oh no, the best contrarian indicator has spoken about BP.
From the Maddmoney website: "During his “Eureka Moment” segment, Jim Cramer told viewers of his “Mad Money” TV show that BP is not too large to fail. In fact, he thinks its a real possibility that the Gulf disaster could could easily swallow up the entire company. “Because of the potential for a near infinite number of claims from the Gulf of Mexico oil spill,’ Cramer said, “bankruptcy is very much on the table for BP.”
"Cramer said the BP oil disaster should not be compared to the Exxon Valdez spill, but rather to the asbestos industry, which has completely wiped out due to the large number of claims it was hit with.”It’’s magical thinking to believe the company’s cash flow of around $7 billion a quarter is enough to get them through the disaster,” he said. Cramer said this would be especially true if a big storm blows through the Gulf of Mexico.
“if we get indictments,” he said, “the claims will overwhelm the company, and it will be in BP’s best interest to file bankruptcy in order to manage the process.”
It seems that the economic honeymoon, as previously reported by all the "good news" in the media, will be over soon.
US GDP in Q1, which had been published as 3.0% annual growth has now been revised down to 2.7 % annual rate. The disappointing numbers reflect a smaller gain in consumer spending and a bigger trade gap.
According to Bloomberg, the "revised figures showed an economy that was more dependent on inventory restocking and less driven by demand from consumers and businesses before the European debt crisis intensified. Unemployment, combined with the turmoil in financial markets and a lack of inflation, are among reasons Federal Reserve policy makers this week reiterated a pledge to keep interest rates low".
"GDP was forecast to grow at a 3 percent annual pace, according to the median estimate of 79 economists surveyed. Projections ranged from gains of 2.4 percent to 3.6 percent. The world’s largest economy expanded at a 5.6 percent pace in the last three months of 2009.
Today’s GDP report is the third for the quarter. The advance estimate for second-quarter growth is due July 30, when the Commerce Department will also issue its annual revision to growth figures covering the past three years".
"Consumer spending, which accounts for about 70 percent of the economy, rose at a 3 percent pace last quarter, compared with the 3.5 percent the government estimated last month and a 1.6 percent gain in the prior three months. The first-quarter increase was the biggest since 2007.
The revision reflected smaller increases in spending on services than previously thought".
Phil Davis is right on today:
So this is gold analysis, using the popular GLD ETF:
This is slightly better than oil (please see previous post). The latest monthly and weekly signals are both buys, while the latest daily signal is a sell. This could indicate weakness is coming and that GLD is entering a trading range. This will be confirmed if the score drops to +55 (currently +75).
Note: To run the tool yourself on any stock, use this link (2 months free, risk-free).
We mentioned a couple of months ago that oil was in a trading range. This is the latest graphical analysis by INO's tool.
Long term indicators only, monthly triangles shown, 2 year chart:
The score of +55 is mildly bullish, but note that the last signal is a sell.
Short term, monthly, weekly, and daily triangles shown, 3 months
The last monthly signal is a sell (see above), the last weekly signal is a buy, and the last daily signal is a sell.
This analysis shows major discrepancies. The trading range continues.
Note: To run the tool yourself on any stock, use this link (2 months free, risk-free).
Natural gas storage numbers were released yesterday. The current amount in storage is 2.64Tcf, about the same as last year, but still at the very top of the 5-year average channel:
This is actually the first slightly (very slightly) bullish sign. We have to pay very close attention in the next two weeks to see if the rate of increase is slowing down.
Shares of BP are down nearly 9% in London today, reaching its lowest levels in 14 years.
In addition, BP is no longer Europes's largest oil company.
The latest publicly announced reason is that first tropical storm of the hurricane season is forming this weekend. Thunderstorms are intensifying in the Caribbean off Honduras and Nicaragua.
BP has been capturing up to 27,000 barrels of oil out of a now estimated... 65,000 daily. The lies, lies and lies!
Still holding BP 35 and 25 straddles, will update later today.
BP is trading around $27 in pre-market the U.S., still a long ways to go.
Amazingly, while we are told that economic recovery is around us, stock markets still very high levels, and while publicly European countries are cutting deficits, Ben Bernanke seems to know a lot more what what he is telling publicly. He is reportedly fighting his colleagues at the Fed to continue quantitative easing and fight deflation.
According to Mr. Ambrose Evans-Pritchard in the Telegraph in the U.K., Bernanke is "waging an epochal battle behind the scenes for control of US monetary policy, struggling to overcome resistance from regional Fed hawks for further possible stimulus to prevent a deflationary spiral". "Fed watchers say Mr Bernanke and his close allies at the Board in Washington are worried by signs that the US recovery is running out of steam".
"The ECRI leading indicator published by the Economic Cycle Research Institute has collapsed to a 45-week low of -5.7 in the most precipitous slide for half a century. Such a reading typically portends contraction within three months or so".
"Key members of the five-man Board are quietly mulling a fresh burst of asset purchases, if necessary by pushing the Fed's balance sheet from $2.4 trillion (£1.6 trillion) to uncharted levels of $5 trillion. But they are certain to face intense scepticism from regional hardliners. The dispute has echoes of the early 1930s when the Chicago Fed stymied rescue efforts".
"We are now walking on deflationary quicksand," said Albert Edwards from Societe Generale.
Read entire article here.
The Fed's balance sheet has grown significantly and has changed considerably in these last few years of the financial crisis.
The biggest changes? Mortgage-backed securities and Funds related the Bear Stearns and AIG. Chart by the Wall Street Journal:
As RIMM will report results today, the Ottawa Citizen had a great article today on the Apple vs Rim war:
A magnitude 5.0/5.5 earthquake shook Eastern Canada yesterday. The building was shaking really hard and the noises of vibration and things falling were awful. damage was minimal but there was some just north of Ottawa:
The Federal Reserve Flow of Funds report says that there are $2.8T in outstanding municipal debt. With many municipalities and states on the verge of bankruptcy and their fiscal year starting on July 1st, the question is who owns this junk:
Professor Kevin Depew from Mynianville shows a list:
The news keeps getting worse for BP. One wonders what this company had for safety measures. The BBC in the U.K. reports that BP has been forced to remove a cap that was containing some of the oil leak.
"Coast Guard Adm Thad Allen says the move came after an underwater robot bumped into the venting system.
The collision sent gas rising through the vent that carries warm water down to prevent ice-like crystals from forming in the cap.
Separately, Admiral Allen said two people had been killed in a clean-up effort."
In the meantime, the stocks continues its slide towards worthlesness:
Disclaimer: the author is very short BP via very profitable puts.
In the last few months the media was keenly publicizing how the new homes sales in the U.S. were strong and so on, while all along we knew it was due to the home tax credit.
New homes actually fell in May to the lowest level on record, collapsing 33% from April. The Commerce Department Data had not been this bad since 1963. In addition, the demand that was published in prior months was also revised down.
All U.S. regions saw drops and the supply of homes at the current sales rate jumped to 8.5 months’ worth from 5.8 months in April.
Bloomberg reports that the data "confirms the market is stumbling. Sales of existing homes, housing starts, building permits, builder confidence and mortgage applications have all declined.
The S&P Supercomposite Homebuilder index, which includes Toll Brothers Inc. and Lennar Corp., has dropped 28 percent through yesterday since reaching a 19-month high on May 3. The broader S&P 500 Index is down 10 percent from April 23’s 19- month peak".
The Euro is under pressure again. The chart below is from an analysis from INO, clearly showing lower highs and lower lows. MACD is also beginning to roll over and the Euro will retest the 1.20 level. This usually means that the Euro is heading lower, although it is still in a trading range. Watch video.
Target is still parity: 1 Euro = 1 USD. To run the tool yourself on any stock, please use this link (2 months free)
The amazing BP stories (some say lies) continue to be exposed left right and center. According to Reuters, an internal BP document estimated that a "worst-case scenario rate for the Gulf of Mexico oil spill could be about 100,000 barrels per day".
Furthermore, Anadarko Petroleum, one of its partners in the doomed oil well, said that had been negligent in the way operated the installation.
Current U.S. government estimate of up to 60,000 barrels per day. Initially these were publicly stated as 1,000 bpd!
London's Sunday Times reported that BP is planning to raise $50B to cover the cost of the largest oil spill in U.S. history. How low its shares will go remains to be seen. Somehow, the stock still trades around $30.
Reuters adds that "the Financial Times said that BP CEO Tony Hayward was planning to travel to Russia to reassure President Dmitry Medvedev that the oil group is not on the brink of collapse".
A few months back we wrote about the possibility of the Yuan exchange rate changing. The two direct Yuan ETFs are CYB and CNY (click links to receive alerts). As we reported yesterday, Roubini says that the move may backfire for the western world. China itself says any appreciation in its currency alone can not rebalance world growth and it is urging other major countries to implement more fundamental reforms.
Since the announcement, the Yuan has appreciated... 0.3 to 0.4%. Since December 2009, CYB is down 1.03%, and CNY is down 1.39%.
It remains to be seen whether this announcement means any real change. However, it does sound just like another public announcement that means nothing as the currency is still controlled by China and China would not take steps to damage its economy on purpose. Politicians must be happy, and the markets will rally for a short while.
We track all currency ETFs live as one of our Live Tracking sites.
"Be careful what you wish". Professor Nouriel Roubini says that China's decision to unpeg the Yuan could mean the yuan will weaken against the U.S. dollar. That would be the opposite of that the U.S. wants.
China announced that it will slowly and gradually make the yuan "more flexible" after two years of being locked. According to the Reuters report, it was "the move that the U.S. government and others around the world have long been calling for". Not so says Roubini.
"This is the first significant signal in years of a change in Chinese currency policy," "Since they have not changed the previous range for the band -- plus or minus 0.5 percent -- most likely on Monday China will allow the renminbi vs U.S. dollar to move,".
"the renminbi would have to be allowed to depreciate relative to the dollar, a paradoxical outcome,"
Roubini adds: "Even if the Chinese were to allow a gradual renminbi appreciation relative to the U.S. dollar, the size of such appreciation would be modest over the next year, not more than 3 or 4 percent as the trade surplus has shrunk, growth is likely to slow down on China and labor/employment unrest remains of concern to the Chinese."
Reuters says that Roubini's comments mirror those of Li Daokui, adviser to China's central bank on Saturday. He told Reuters in Beijing that the yuan could depreciate against the dollar if the euro falls sharply against the U.S. currency.
Gold has reached a new record high and there is a breakout at $1240. Here is INO's latest video, fresh from today, on 4 ways to trade it. Watch video.
Leaders of European Union governments have apparently agreed to conduct public stress tests of their banks. Bloomberg reports that the ECB has stated it will "absolutely not provide banks with capital should stress tests show they need it". Inquiring minds are wondering where there is any chance that the European stress tests will reveal any serious shortcomings? ;-)
The Europeans seem to be suffering from a a little lack of imagination by copying the same tactics used in the U.S. Hey, it worked in the U.S....
"European Union leaders yesterday decided to publish the results of stress tests on the region’s lenders after Spanish bank officials unexpectedly pledged to make public results on individual banks".
I retrospect, there was nothing possibly good that could come out of the BP oil leakage hearings.
Bloomberg was counting the number of times he said 'I don't know: 66 times.
“Mr. Hayward’s comments today, saying ‘I don’t know’ 66 times, evaporated any feeling of responsibility,” “Any goodwill that the company bought back yesterday eroded today with his testimony” says Matt Eventoff, a partner at New Jersey communications firm, Princeton Public Speaking.
Deepended Suspicions
"In his testimony yesterday, Hayward not only failed to convince lawmakers he was committed to making BP safer, he may have deepened suspicion of the company by repeatedly pleading ignorance to events that took place under his command"
"BP's failure to set safety standards to prevent the Gulf of Mexico oil spill may cost the company control over U.S. oil fields"
Readers know that I make extensive use of options, in particular straddles. Straddles can pay handsomely (as in 200%/300%+ ROIs) in volatile markets, as I have published results several times in the past few months. Phil Davis, the options guru who maintains a great trading daily chat also uses options almost exclusively, but he usually writes (sells) options. Writing options has in general an over 90% success rate, sometimes even higher so it can be quite lucrative for those with larger accounts. As myself, Phil has also appeared on BNN in Canada explaining his strategies. He has written an article on how to buy stocks at a 10 to 20% discount (sometimes more), by using options. Here it is.
How to Buy Quality Value Stocks for a 10%-20% Discount with Phillip Davis’ Option Strategies
By Phil Davis, Phil’s Stock World
If you want to concentrate on investments that give you better prices than those paid by the average retail investor, pick value stocks. This will allow you to stay ahead of the game using very basic option strategies.
The best method to work your way into new bullish positions with value stocks is with the famous Phil’s Buy/Write Strategy. This strategy is the most sensible way to initiate new stock positions using one of the most effective, time-tested tools for dealing with market uncertainty. This strategy allows you to purchase stocks for 10%-20% below their current price. The strategy is called a “Buy/Write” because we buy the stock and write/sell options against it.
Assuming that you want to own 200 shares of a stock, Phil’s Buy/Write Strategy can reliably give you a 10-20% discount off the current market price. It’s simple, easy to follow, and ideal for trading in a volatile market.
Sound investing principles include purchasing stocks that have strong underlying fundamentals, stocks we don’t mind owning for the long-term. Of course, when you buy any stock, another sound investing principle is to scale in . . . enter your position in stages. Why? Because we can’t assume our timing is perfect. By entering a position in stages, we spread the risk over time.
Selling options simultaneously with a stock purchase, using Phil’s Buy/Write Strategy is a way to automatically follow a scaling system without having to monitor the position that closely.
Phil’s Buy/Write Strategy in Action
How does the Buy/Write Strategy work? It’s very simple, and here is an example using a value stock you may want to own today:
Let’s say you want to buy 200 shares of BAC (Bank of America Corp) today at $15.78. Using Phil’s Buy/Write Strategy, you purchase 100 shares of BAC today, June 17, 2011, and simultaneously sell options on the stock: (NOTE: One option contract is equal to 100 shares.)
Sell:
One Jan 2011 $15 call for $2.50
One Jan 2011 $15 put for $1.62
These two option contracts reduce your net cost basis to just $11.66 ($15.78-$2.50-$1.62), and you have taken on two obligations dependent on one of the following scenario taking place:
Scenario #1: BAC is above $15 on Jan 21, 2011.
The call option you sold will be exercised by the person who bought it, and your 100 BAC shares called away at $15. (Your put option will expire worthless to the holder.) The profit on that trade would be $3.52 per share against our net outlay of $11.66, a 31% profit in 7 months.
Scenario #2: BAC is below $15 on Jan 21, 2011.
The put option you sold will be exercised by the person who bought it, and you will be required to buy an additional 100 shares of BAC at $15. (Your call option will expire worthless to the holder.)
Yes, you will have to pay $15 for 100 additional shares of BAC, regardless of its current price, but remember, you got your original 100 shares at net $11.66 (considering the two options you sold), so 100 more shares at $15/share would give you a new net basis of $13.28 -which is 15.8% lower than the current price.
In either scenario, you have acquired or controlled the 200 shares of BAC you wanted to purchase — and you got them at a10-20% discount using Phil’s Buy/Write Strategy.
Recall that sound investing principles start with finding fundamentally sound stocks which are undervalued, have good growth, are optionable, and which you don’t mind owning long term.
In short, if you think BAC is a relatively good deal at $15.60 – why not commit to buying it for $13.16 instead?
Let’s take the BAC example a step further.
In Scenario #2, when January 21, 2011 rolls around, you own 200 shares of BAC, at a basis of $13.16. You can continue to sell calls against the stock.
Let’s say BAC falls all the way to $12 (down 30%), and your net basis is $13.16. You can still sell $15 calls for about $0.25 a month. That’s $3 per year (per share) against your $13.16 (22.8% annual). Plus, you’ll make an additional $1.84/share if BAC closes above $15 on any option expiration date.
Learning to use options effectively can enhance your investing life!
We identify dozens of trades like this every week at Phil’s Stock World. While you can do this with any stock, we’re able to identify unique option opportunities that make certain stocks a little more favorable than others — and we can teach you to do it, too.
At this point you may be saying to yourself: ”If I can learn to buy all my stocks for 15% to 20% discounts, I bet my trading performance will improve.”
That’s exactly what hedge fund managers do, and there’s no reason you can’t learn to do it as well!
We have featured hundreds of these opportunities to members of Phil’s Stock World, and in this scary and volatile market, this strategy is one of the best ways to capitalize on volatility while hedging the risk on your upside strategies.
If the market ends up flat-lining, however, you will be positioned in stocks at good prices that can generate a very reasonable monthly income — which will keep you flexible in a challenging market!
Note: You can try the PSW Report Membership Package ($23/month) for a 20% introductory discount (or one of our other option trading services). Phil’s Stock World Report features some of these trades weekly. If you want live alerts of trade ideas as we identify them, or want to view our daily trading chat live, then check out a Basic or Premium Membership.
For some bizarre reason BP was upgraded by some agency today. The stock responded by doing not much, still oscillating between red and green. Somebody is trying to save this company from going for credit protection.
Whether it goes to $100 or it really collapses for good is nearly irrelevant for straddles. Here are some for July:
Options are dangerous and may cause 100% loss. Please do your own due diligence.
UNG came crashing down to Earth today, following its usual pattern, down over 4% today:
HND in Toronto, on the other hand, plays its roles as a leveraged inverse ETF:
Dislaimer: long HND
Note: You may receive technical analysis and alerts of these stocks, sent automatically to you, by entering the symbols in the Technical Trend Analysis Tool, (powered by INO).
MMS, Minerals Management Service, was the agency responsible for safety and inspections of oil drills in the gulf. It seems to have been a revolving door lately in terms of directors and heads.
Watch video:
Forget the Rhetoric: Europe Loves a Weak Euro
Brazilian news agency Agencia Estado reports today that French President Nicolas Sarkozy finally admits that he welcomes the boost in competitiveness of euro area resulting from the drop of the Euro.
Forget all the talk about a 'strong Euro", similar to all the talk about a 'strong US dollar'. Low currencies are great to increase the exports of weak economies.
Speaking at an event for small and medium enterprises, the president said he does not worry about the fall of the common European currency. Sarkozy also said Europe's economic growth remains fragile and needs to be strengthened at the same time that public finances should be remedied. The declines in the euro has been exacerbated by fears of investors with high levels of public debt in the euro area. To try to control these concerns, the bloc's members have created a stability fund of € 440 billion to countries that may not be able to refinance solely from the markets.
Sarkozy said that the fall of the euro makes French products more competitive and it is beginning to have an impact on exports. The increase in competitiveness "goes in the right direction," the president said, adding that there is no reason for the euro area suffer from a less competitive currency.
Speaking of BP's lies, lies and more lies, Barry Ritholtz takes the prize today with this article:
"LONDON (The Borowitz Report) – In what is being called a game-changer for the embattled oil company, British Petroleum announced today that it has developed a new technology to convert lies into energy.
At a press conference at corporate headquarters in London, BP CEO Tony Hayward said that environmentalists would embrace the new technology “because lies are a totally renewable resource.”
Illustrating the impact of BP’s new technology, Mr. Hayward told reporters, “Over the past month alone, my words could power the city of London for a year.”
[...]
Remember those 1,000 barrels per day for the BP oil leak, and revised later to maybe 15,000? The official numbers tonight are "up to 60,000". If that were not bad enough, Matt Simmons was on TV again today refuting that new estimate. He says the leak is ... around 120,000 barrels per day.
In addition:
- leak under the ocean spreading very fast, the oil lake underneath the surface of the water could be covering up to 40% of the Gulf of Mexico.
- the leak has no casing: a relief well will not work,
- only possible resolution is a nuclear explosion to convert the rock to glass
The stock market rebounding today offers another great opportunity for straddles. Here are straddles for the Nasdaq, financials, and oil using our favorites ETFs. These will greatly benefit if the market crashes or goes substantially higher.
QQQQ (June and July) and XLF (July):
UCO (June and July):
Computed with StraddlesCalc Tool, which shows the maximum moves required by the underlying ETF for the options position to achieve profitability.
Note: You may receive technical analysis and alerts of these stocks, sent automatically to you, by entering the symbols in the Technical Trend Analysis Tool, (powered by INO).
Please do your own due diligence. This is not advice. Options are very dangerous and may cause 100% loss.
The price of natural gas has recovered somewhat lately, bringing the dreadful UNG with it.
These are straddles (strangles) for UNG for June, July, and October. Note that June only has 3 days left, so they are in the beyond acceptable risk category. They will only be profitable if UNG moves about 8%.
Computed with StraddlesCalc.
This is not advice. Please do your own due diligence. Options are dangerous and may cause 100% loss.
Heavy hitter and ubiquitous Nouriel Roubini was on TV earlier today. He says the risk of a double dip is highest in the Eurozone, problems are severe. Sees risks over double dip are higher than 50%. He comments on the labor market which "shows weakness". He says that even if the US creates 100,000 jobs per month, excluding census, we need 150,000. Unemployment will stay around 1% or rise.
If you keep wondering why the US budget deficits keeps ballooning, consider that that the cost of saving Freddie Mac and Fannie Mae could be as high as $1 trillion. The companies are now 80%owned by U.S. taxpayers and have already used $145B from a line of government credit.
Acording to Bloomberg, both companies own or guarantee 53% of the the $10.7T in residential mortgages. "Millions of bad loans issued during the housing bubble remain on their books, and delinquencies continue to rise".
"The CBO calculated in August 2009 that the companies would need $389 billion in federal subsidies through 2019, based on assumptions about delinquency rates of loans in their securities pools. The White House’s Office of Management and Budget estimated in February that aid could total as little as $160 billion if the economy strengthens.
If housing prices drop further, the companies may need more. Barclays Capital Inc. analysts put the price tag as high as $500 billion in a December report on mortgage-backed securities, assuming home prices decline another 20 percent and default rates triple".
Bloomberg reports this morning that Representative Steve Cohen, with support from Louisiana State Treasurer John Kennedy, said that the Obama administration should consider placing the company in receivership to preserve its assets "because BP is likely to end up in bankruptcy", "bankruptcy is a possibility and state and federal governments need to plan for it".
However, restructuring experts say that bankruptcy is unlikely to make the company avoid paying claims said. BP claims is has already spent more than $1.43B to stop the leak and clean it up. There were bizarre reports yesterday that the company would be increasing he amount of oil collected to up to 60,000 or 80,000 barrels per day, after the company said it had increased collection to 17,000 barrels per day. Apparently the initial estimates of the leak were 1,000 barrels per day (!). Just how much oil is flowing on that leak?
This morning, Fitch downgraded BP's credit rating by 6 notches, from AA to BBB.
Back on June 2nd, a Credit Suisse report said that BP faces more than 200 lawsuits, and BP’s liabilities include $37B in cleanup and potential litigation expenses, but this was when the oil leak was considered much smaller.
The company's chart is a disaster:
However, our straddles continue to perform extremely well (more later).
Goldman Sachs has its Code of Business Conduct and Ethics online. On page 4, section III, this is the first sentence:
Waivers of this code
From time to time, the firm may waive certain provisions of this code.
Thanks to Seamus for the lead.
Reuters reports that BP could increase the volume of oil it will capture from the leaking well from about 15,000 barrels a day now to 40,000-53,000 barrels by the end of June and 60,000-80,000 by mid-July, but "it could still not guarantee collecting all the gushing crude".
80,000?! Just how much oil is/was flowing on that well?
BP shares continues to sink.
According to a Reuters report today, Spain officially acknowledged the liquidity freeze on some Spanish banks in the interbank market. Its Treasury general said the government was working to restore confidence through budget cuts and structural economic reforms.
"It's definitely a problem," Mr. Ocana said when asked about the reported credit squeeze. He also said Madrid was not negotiating any financial aid package: "Spain does not need additional financing from any international institution. The rumor is false and I deny it,".
Spain needs to refinance 16.2B euros of bonds in July. The premiums it pays to borrow have been rising. The liquidity freeze was affecting savings banks and small banks.
Breaking news: Moody’s Investors Service said it downgraded Greece’s government bond ratings by four levels to Ba1 from A3, to what is referred to as 'junk'.
Has the Euro been at parity with the USD? Actually, the Euro's all-time lows versus the USD is even lower at 0.83!
According tot hsi frsesh news video by INO, the Euro is fundamentally overvalued (as in the price of food, pricing of homes, etc). Target is still... parity.
The ETF to use is FXE (click to receive buy/sell alerts)
Watch video.
(To run the tool yourself, use this link for 2-months free access)
A new short video on the spot gold market has been released by INO. The analysis shows the difference in analysis using Japanese candlestick charts (which show important elements usually not seen using traditional Western charts).
Note that gold currently has a +100 score.
Watch video.
In another sign of bearishness for the market, John Williams’ updated M3 money supply chart shows a very steep in M3 (with data from the St. Luis Fed):
Bloomberg reports the obvious today, that European banks will be squeezed for funding - and profits - for years to come.
Note that we track top financial stocks live on this site.
"European banks at risk of writedowns from the sovereign debt crisis face a funding squeeze that may depress earnings, curb lending and imperil economic recovery in the region.
Investors are shunning bank securities on concern Greek, Portuguese and Spanish bonds held by the lenders will plunge in value. Bank bond sales slowed in May to the lowest since Lehman Brothers Holdings Inc.’s failure in 2008 as the extra yield buyers demand to hold the securities over government debt soared to the highest this year. Firms are wary of lending to each other, deposting record funds with the European Central Bank".
"The central bank is preventing a crisis by providing banks with unprecedented funding. In substituting long-term money with shorter-maturity ECB cash, policymakers are making it harder to wean banks off life support as well as the short-term financing that regulators blame for the credit crisis".
"Banks are still struggling to borrow even from one another and loans with a maturity of more than one month are “rare and expensive,” making them depend more on ECB funding, brice Vanamme, a London-based analyst at Deutsche Bank AG, wrote in a note to clients on June 9".
"Firms are leaving cash with the central bank instead of lending it to other banks amid concern that counterparties may collapse. Deposits have also climbed to a record as the ECB flooded money markets with cash since 2008".
“Increased reliance on short-term ECB loans and interbank funding runs counter to the rules being proposed by the Basel Committee on Banking Supervision. The committee, which sets minimum standards for banks in 27 countries, plans to require banks to maintain a “net stable funding ratio” of 100 percent, meaning they would need an amount of longer-term loans or deposits equal to their financing needs for 12 months".
Geoge Soros gave a speech this week in which he reiterates that part II of the financial crisis is under way and the current situation reminiscent of the Great Depression. Governments are under pressure to cut deficits, while the economic activity is weak. According to Mr. Soros, "The collapse of the financial system as we know it is real, and the crisis is far from over. Indeed, we have just entered Act II of the drama".
This is his speech from Vienna:
"In the week following the bankruptcy of Lehman Brothers on Sept. 15, 2008 — global financial markets actually broke down, and by the end of the week, they had to be put on artificial life support. The life support consisted of substituting sovereign credit for the credit of financial institutions, which ceased to be acceptable to counterparties.
As Mervyn King of the Bank of England brilliantly explained, the authorities had to do in the short term the exact opposite of what was needed in the long term: they had to pump in a lot of credit to make up for the credit that disappeared, and thereby reinforce the excess credit and leverage that had caused the crisis in the first place. Only in the longer term, when the crisis had subsided, could they drain the credit and re-establish macroeconomic balance.
This required a delicate two-phase maneuver just as when a car is skidding. First you have to turn the car into the direction of the skid and only when you have regained control can you correct course.
The first phase of the maneuver has been successfully accomplished — a collapse has been averted. In retrospect, the temporary breakdown of the financial system seems like a bad dream. There are people in the financial institutions that survived who would like nothing better than to forget it and carry on with business as usual. This was evident in their massive lobbying effort to protect their interests in the Financial Reform Act that just came out of Congress. But the collapse of the financial system as we know it is real, and the crisis is far from over.
Indeed, we have just entered Act II of the drama, when financial markets started losing confidence in the credibility of sovereign debt. Greece and the euro have taken center stage, but the effects are liable to be felt worldwide. Doubts about sovereign credit are forcing reductions in budget deficits at a time when the banks and the economy may not be strong enough to permit the pursuit of fiscal rectitude. We find ourselves in a situation eerily reminiscent of the 1930s. Keynes has taught us that budget deficits are essential for counter cyclical policies, yet many governments have to reduce them under pressure from financial markets. This is liable to push the global economy into a double dip.
It is important to realize that the crisis in which we find ourselves is not just a market failure but also a regulatory failure, and even more importantly, a failure of the prevailing dogma about financial markets. I have in mind the Efficient Market Hypothesis and Rational Expectation Theory. These economic theories guided, or more exactly misguided, both the regulators and the financial engineers who designed the derivatives and other synthetic financial instruments and quantitative risk management systems which have played such an important part in the collapse. To gain a proper understanding of the current situation and how we got to where we are, we need to go back to basics and re-examine the foundation of economic theory.
I have developed an alternative theory about financial markets which asserts that financial markets do not necessarily tend toward equilibrium; they can just as easily produce asset bubbles. Nor are markets capable of correcting their own excesses. Keeping asset bubbles within bounds have to be an objective of public policy. I propounded this theory in my first book, “The Alchemy of Finance,” in 1987. It was generally dismissed at the time, but the current financial crisis has proven, not necessarily its validity, but certainly its superiority to the prevailing dogma.
Let me briefly recapitulate my theory for those who are not familiar with it. It can be summed up in two propositions. First, financial markets, far from accurately reflecting all the available knowledge, always provide a distorted view of reality. This is the principle of fallibility. The degree of distortion may vary from time to time. Sometimes it’s quite insignificant, at other times it is quite pronounced. When there is a significant divergence between market prices and the underlying reality I speak of far from equilibrium conditions. That is where we are now.
Second, financial markets do not play a purely passive role; they can also affect the so-called fundamentals they are supposed to reflect. These two functions that financial markets perform work in opposite directions. In the passive or cognitive function, the fundamentals are supposed to determine market prices. In the active or manipulative function market, prices find ways of influencing the fundamentals. When both functions operate at the same time, they interfere with each other. The supposedly independent variable of one function is the dependent variable of the other, so that neither function has a truly independent variable. As a result, neither market prices nor the underlying reality is fully determined. Both suffer from an element of uncertainty that cannot be quantified. I call the interaction between the two functions reflexivity. Frank Knight recognized and explicated this element of unquantifiable uncertainty in a book published in 1921, but the Efficient Market Hypothesis and Rational Expectation Theory have deliberately ignored it. That is what made them so misleading.
Reflexivity sets up a feedback loop between market valuations and the so-called fundamentals which are being valued. The feedback can be either positive or negative. Negative feedback brings market prices and the underlying reality closer together. In other words, negative feedback is self-correcting. It can go on forever, and if the underlying reality remains unchanged, it may eventually lead to an equilibrium in which market prices accurately reflect the fundamentals. By contrast, a positive feedback is self-reinforcing. It cannot go on forever because eventually, market prices would become so far removed from reality that market participants would have to recognize them as unrealistic. When that tipping point is reached, the process becomes self-reinforcing in the opposite direction. That is how financial markets produce boom-bust phenomena or bubbles. Bubbles are not the only manifestations of reflexivity, but they are the most spectacular.
In my interpretation equilibrium, which is the central case in economic theory, turns out to be a limiting case where negative feedback is carried to its ultimate limit. Positive feedback has been largely assumed away by the prevailing dogma, and it deserves a lot more attention.
I have developed a rudimentary theory of bubbles along these lines. Every bubble has two components: an underlying trend that prevails in reality and a misconception relating to that trend. When a positive feedback develops between the trend and the misconception, a boom-bust process is set in motion. The process is liable to be tested by negative feedback along the way, and if it is strong enough to survive these tests, both the trend and the misconception will be reinforced. Eventually, market expectations become so far removed from reality that people are forced to recognize that a misconception is involved. A twilight period ensues during which doubts grow and more and more people lose faith, but the prevailing trend is sustained by inertia. As Chuck Prince, former head of Citigroup, said, “As long as the music is playing, you’ve got to get up and dance. We are still dancing.” Eventually a tipping point is reached when the trend is reversed; it then becomes self-reinforcing in the opposite direction.
Typically bubbles have an asymmetric shape. The boom is long and slow to start. It accelerates gradually until it flattens out again during the twilight period. The bust is short and steep because it involves the forced liquidation of unsound positions. Disillusionment turns into panic, reaching its climax in a financial crisis.The simplest case of a purely financial bubble can be found in real estate. The trend that precipitates it is the availability of credit; the misconception that continues to recur in various forms is that the value of the collateral is independent of the availability of credit. As a matter of fact, the relationship is reflexive. When credit becomes cheaper, activity picks up and real estate values rise. There are fewer defaults, credit performance improves, and lending standards are relaxed. So at the height of the boom, the amount of credit outstanding is at its peak, and a reversal precipitates false liquidation, depressing real estate values.The bubble that led to the current financial crisis is much more complicated. The collapse of the subprime bubble in 2007 set off a chain reaction, much as an ordinary bomb sets off a nuclear explosion. I call it a superbubble. It has developed over a longer period of time, and it is composed of a number of simpler bubbles. What makes the superbubble so interesting is the role that the smaller bubbles have played in its development.The prevailing trend in the superbubble was the ever-increasing use of credit and leverage. The prevailing misconception was the belief that financial markets are self-correcting and should be left to their own devices. President Reagan called it the “magic of the marketplace,” and I call it market fundamentalism. It became the dominant creed in the 1980s. Since market fundamentalism was based on false premises, its adoption led to a series of financial crises. Each time, the authorities intervened, merged away, or otherwise took care of the failing financial institutions, and applied monetary and fiscal stimuli to protect the economy. These measures reinforced the prevailing trend of ever-increasing credit and leverage, and as long as they worked, they also reinforced the prevailing misconception that markets can be safely left to their own devices. The intervention of the authorities is generally recognized as creating amoral hazard; more accurately it served as a successful test of a false belief, thereby inflating the superbubble even further.It should be emphasized that my theories of bubbles cannot predict whether a test will be successful or not. This holds for ordinary bubbles as well as the superbubble. For instance, I thought the emerging market crisis of 1997-98 would constitute the tipping point for the superbubble, but I was wrong. The authorities managed to save the system and the superbubble continued growing. That made the bust that eventually came in 2007-8 all the more devastating.What are the implications of my theory for the regulation of the financial system?
First and foremost, since markets are bubble-prone, the financial authorities have to accept responsibility for preventing bubbles from growing too big. Alan Greenspan and other regulators have expressly refused to accept that responsibility. If markets can’t recognize bubbles, Greenspan argued, neither can regulators — and he was right. Nevertheless, the financial authorities have to accept the assignment, knowing full well that they will not be able to meet it without making mistakes. They will, however, have the benefit of receiving feedback from the markets, which will tell them whether they have done too much or too little. They can then correct their mistakes.
Second, in order to control asset bubbles it is not enough to control the money supply; you must also control the availability of credit. This cannot be done by using only monetary tools; you must also use credit controls. The best-known tools are margin requirements and minimum capital requirements. Currently, they are fixed irrespective of the market’s mood, because markets are not supposed to have moods. Yet they do, and the financial authorities need to vary margin and minimum capital requirements in order to control asset bubbles.
Regulators may also have to invent new tools or revive others that have fallen into disuse. For instance, in my early days in finance, many years ago, central banks used to instruct commercial banks to limit their lending to a particular sector of the economy, such as real estate or consumer loans, because they felt that the sector was overheating. Market fundamentalists consider that kind of intervention unacceptable, but they are wrong. When our central banks used to do it, we had no financial crises to speak of. The Chinese authorities do it today, and they have much better control over their banking system. The deposits that Chinese commercial banks have to maintain at the People’s Bank of China were increased 17 times during the boom, and when the authorities reversed course, the banks obeyed them with alacrity.
Third, since markets are potentially unstable, there are systemic risks in addition to the risks affecting individual market participants. Participants may ignore these systemic risks in the belief that they can always dispose of their positions, but regulators cannot ignore them because if too many participants are on the same side, positions cannot be liquidated without causing a discontinuity or a collapse. They have to monitor the positions of participants in order to detect potential imbalances. That means that the positions of all major market participants, including hedge funds and sovereign wealth funds, need to be monitored. The drafters of the Basel Accords made a mistake when they gave securities held by banks substantially lower risk ratings than regular loans: they ignored the systemic risks attached to concentrated positions in securities. This was an important factor aggravating the crisis. It has to be corrected by raising the risk ratings of securities held by banks. That will probably discourage loans, which is not such a bad thing.Fourth, derivatives and synthetic financial instruments perform many useful functions, but they also carry hidden dangers. For instance, the securitization of mortgages was supposed to reduce risk through geographical diversification. In fact, it introduced a new risk by separating the interest of the agents from the interest of the owners. Regulators need to fully understand how these instruments work before they allow them to be used, and they ought to impose restrictions guard against those hidden dangers. For instance, agents packaging mortgages into securities ought to be obliged to retain sufficient ownership to guard against the agency problem.Credit-default swaps (C.D.S.) are particularly dangerous. They allow people to buy insurance on the survival of a company or a country while handing them a license to kill. C.D.S. ought to be available to buyers only to the extent that they have a legitimate insurable interest. Generally speaking, derivatives ought to be registered with a regulatory agency just as regular securities have to be registered with the S.E.C. or its equivalent. Derivatives traded on exchanges would be registered as a class; those traded over-the-counter would have to be registered individually. This would provide a powerful inducement to use exchange traded derivatives whenever possible.
Finally, we must recognize that financial markets evolve in a one-directional, nonreversible manner. The financial authorities, in carrying out their duty of preventing the system from collapsing, have extended an implicit guarantee to all institutions that are “too big to fail.” Now they cannot credibly withdraw that guarantee. Therefore, they must impose regulations that will ensure that the guarantee will not be invoked. Too-big-to-fail banks must use less leverage and accept various restrictions on how they invest the depositors’ money. Deposits should not be used to finance proprietary trading. But regulators have to go even further. They must regulate the compensation packages of proprietary traders to ensure that risks and rewards are properly aligned. This may push proprietary traders out of banks, into hedge funds where they properly belong. Just as oil tankers are compartmentalized in order to keep them stable, there ought to be firewalls between different markets. It is probably impractical to separate investment banking from commercial banking as the Glass-Steagall Act of 1933 did. But there have to be internal compartments keeping proprietary trading in various markets separate from each other. Some banks that have come to occupy quasi-monopolistic positions may have to be broken up.While I have a high degree of conviction on these five points, there are many questions to which my theory does not provide an unequivocal answer. For instance, is a high degree of liquidity always desirable? To what extent should securities be marked to market? Many answers that followed automatically from the Efficient Market Hypothesis need to be re-examined.
It is clear that the reforms currently under consideration do not fully satisfy the five points I have made, but I want to emphasize that these five points apply only in the long run. As Mervyn King explained, the authorities had to do in the short run the exact opposite of what was required in the long run. And as I said earlier, the financial crisis is far from over. We have just ended Act II. The euro has taken center stage, and Germany has become the lead actor. The European authorities face a daunting task: they must help the countries that have fallen far behind the Maastricht criteria to regain their equilibrium while they must also correct the deficiencies of the Maastricht Treaty which have allowed the imbalances to develop. The euro is in what I call a far-from-equilibrium situation. But I prefer to discuss this subject in Germany, which is the lead actor, and I plan to do so at the Humboldt University in Berlin on June 23. I hope you will forgive me if I avoid the subject until then."
