Monthly Archives: June 2011

Lesson on risk reversal positions

I was reading a Reuters article this morning, and they mentioned how euro risk reversals are at a 6-month high, presumably because hedge funds are shorting the euro. For the sake of news, the euro has been unable to break the $1.4500 mark lately, and is at $1.4169 after dropping 271 pips today (.0271 percentage points). Good news for those who think the Fed is trying to inflate away our debts, I’ll be doing a post on that bullshit sometime soon (basically people who think that are fuckin’ morons). BUT, just reading that one headline I realized I have no idea what a risk reversal is for. So, I did some fuckin’ readin’ and now I know what it is. And because I took the time to read up on what they’re used for… I’m gonna spread some god damn knowledge on ya ass. For clarity, I’m gonna explain it as if my friend, Petrone, is bullish on Microsoft stock (he heard they bought Skype and thinks they’re gonna gain like 20 fuckin’ points or some shit).

So, Petrone hears about the Skype buyout and gets all excited about Microsoft stock. It’s at about $24/share, but let’s assume it’s $50/share for this example. Petrone thinks Microsoft is gonna enjoy a big rally and wants to go long the stock. But, he doesn’t just wanna have a straight-up position in a market as uncertain as today’s. So instead of just buying the stock for $24/share, he’s going to enter into 2 option contracts, this is the risk reversal strategy.

First, a quick refresher on the options he’ll buy. Petrone will go long a call option. Buying a call option means you pay a premium (say $5) for the right to buy the underlying (MSFT stock in this case, $50 right now) at a specified future price, the strike price (say $60), at or before the expiration date (say 1 year). If you are the buyer of the option you don’t have to purchase the underlying, you just pay the premium for the right to purchase it before the contract expires. So, when Petrone is long a call option, he’s hoping the underlying current stock price (spot) will be greater than the strike price before the option expires. If that’s the case, he can turn around and sell the stock he just bought for the market/spot price. If the difference between the spot and strike is greater than the premium he paid, then he’ll make a profit. In our example, if MSFT is worth $70/share at some point before the expiration, Petrone will make a profit of $5 ($70-$60-$5=$5) if he exercises the option at that point. He pays the premium when purchasing the option and the strike price when exercising the option, then sells the asset at the market/spot price and hopefully profits.

Now, in the case of a risk reversal, Petrone is going to short a put option before he’s does the above. Much like buying a call option, shorting a put option means Petrone thinks MSFT’s spot price will rise in the future. Again, the buyer of a put option pays a premium (say $5) for the right to sell an underlying asset to the seller of the option, Petrone, at the strike price (say $40). So, the buyer is hoping the spot price will fall below the strike price by at least the value of the premium, because then he’ll be selling the stock at a strike that’s higher than the market/spot price and will profit. In Petrone’s case, he’s going to be the seller of the put option, so he’s hoping the spot price stays above the strike price (the buyer of the put option won’t exercise the option, and Petrone will make a profit of $5, the premium).

The reason Petrone shorts a put option first, is so he can use the premium he earns from it, $5, to buy the call option at $5. So, if the spot price is originally $50 and never falls below $40 or rises above $60, neither option will be exercised, and he’ll break even. If the spot rises above $60, then Petrone will exercise the call option and make a profit of the spot minus $60. For instance, if 7 months after he enters both contracts the spot is $70, he’ll make $10 (spot-strike-call premium+put premium; $70-$60-$5+$5=$10). If the spot falls below $40, the buyer of the put he sold will exercise the option, and he’ll lose the amount it falls below $40. For instance, if 7 months later the spot is $30, he’ll lose $10 ($30-$40-$5+$5=-$10).

So, instead of just buying MSFT at a $50 face value, Petrone can make a synthetic long position with both a long call and short put with very little money to begin with ($0 in our example). Risk is reduced big time as you can see, and so is the possible reward. The increased leverage he can use more than makes up for the difference in volatility. If there’s a lot of volatility (spot goes ±$10) there’s a fat possible gain/loss with big leverage, but if there’s low volatility (spot above $40/below $60) there’s very little cost, if any.

Back to the original reason for writing about this, euro risk reversals are at a 6-month high. A high risk reversal means that the call option is more volatile than the put option. In other words, long positions on the euro/dollar are riskier positions than short positions. So, the risk reversal levels are good indicators of where an asset’s price is going, especially on currencies. In this case, the euro is not going to be doing well in the future.

… That probably made no fuckin’ sense.

Advertisements

Good documentary

Sort of a fucked up picture now that I look at it… not dopies

For those like myself who have only a few tidbits of knowledge of the Israeli-Palestinian conflict, here’s a good six-part documentary done by Al Jazeera a few years ago. Al Jazeera is usually very good at being unbiased, but I will say this is a little slanted towards Palestinians. Nonetheless, good series with a lot of facts and only about an hour and a half in total.

US banks’ CDS exposure to Europe

Read this. The author, economist Kash Mansori, had to do a shitload of research to get these numbers, but it shows how bad things could be for the US in the case of European credit event. It’s some hard evidence that US institutions have just as much on the line as Europeans from a default by one of the PIGS.

Equities keep plummeting

Dow is down 172 11,951 and S&P is down 18 to 1,270 on the day. I’m beginning to get the feeling that the markets are playing off the news too much. Not only that, but expectations for the year were just incredibly too high. Now, Obama’s analogy of “if you get hit by a truck… it’s gonna take a while to mend ya know?” may be extremely retared, but he’s not wrong on the original point. You don’t have the Dow literally lose like 50% over a year and a half and just expect 3% yearly growth right off the bat. To reiterate what many have pointed out, this was the worst recession we’ve had since the Great Depression. These high expectations are only hindering growth. Record corporate profits obviously imply they’re hoarding a lot of cash, but it’s not like they’re gonna keep it forever. That money will be reinvested. Unemployment will eventually decrease. Have some faith in the market.

Larry Fink was on CNBC today giving his insights. Dudes a baller, I usually believe almost everything he says. Plus he just doesn’t look like a scumbag. He’s bullish on equities. One of his main reasons is the fact that the bond market is extremely overstuffed. I just posted a day or two ago about how some people are hoppin’ on bonds because they’re just looking for any safe rate of return. Well, there’s almost no profit opportunity now. The private sector benefitting a lot with the weak dollar and are in a great position to grow. Honestly, there’s not much room for this economy to go south unless you consider a depression a possibility. Which it’s not, and a “double dip” won’t happen either. There’s far too much liquidity for another recession. The worst possibility I see is just very slow growth for another year or two from uneasy investment. But the markets, and the economy as well, will pick up.

As for my thoughts on the speculation of QE3, I’ve found myself getting consistently annoyed of those who say it has failed. Investment has increased over the past year. The unemployment rate has dropped over 1% since it started, and I’d venture to say that without QE it wouldn’t have dropped nearly that much (as in it would probably be the same). People are so quick to say QE has failed because the growth is so slow, but where’s the evidence that the economy would be in a better position without it? I don’t see it and I haven’t heard it. All these fuckin’ bears are just scaring everybody, that’s what I think. A little more optimism would help ease consumer confidence.

What an IDIOT!

Love how the guy with the camera is like “that will be mine one day… betchyu that’s a lambo”. Nah brah. Ain’t gonna be yours one day. God… I bet that guy shat his pants the second he realized he was dumpin’ that thing in the water. Then again, if you can not only afford a $2 million car, but actually BUY a $2 million car… this doesn’t even phase you right? He probably did it on purpose come to think of it. Talkin’ to his other super loaded friend he was probably like “I’ll bet you $1 million I can get my Bugatti to drive on water for at least 5 seconds”. Just tossin’ money around while everyone else is lining up for food stamps. What a life.

Look familiar?

I’m at a crossroads right now. It’d be unreal if DeShawn Stevenson somehow shutdown LeBron tonight. But don’t kid yourself… it’d be a defining career moment to see LBJ put up 40 tonight and shut everyone up. As someone who fucking hates how much ESPN and other people can blow one god damn game out of proportion, I love when people shut the media up. On the other hand… DeShawn’s been so heinous yet so unreal it’s bizarro world out there. A 3 in Bron’s face would be dopies.

Oh you gotta be HEININ’ me Tennessee

I am emotionally distressed because I can’t fuck Larissa Riquelme… so this pic is illegal

Apparently this isn’t a joke. Tennessee has made it illegal for shocking or offensive images that could cause emotional distress to be posted on the internet. I don’t even know what to say about this. You guys are fucked in the head. That’s about all I got. The governor actually signed this into law… an elected official. Well suck my dick and call me Sally this is just absurd. Fuckin’ twilight zone shit down there, they can just ignore the First Amendment completely and the only thing we say is “jesus those people are stupid”.

DOPIES!

Hate all you want… these are fuckin’ dope. Who cares if they’re not actually a throwback to any kind of jersey. I need one of these like I need air: I’m not sure how, but I’m pretty sure I’ll die if I don’t have it. God DAMN I can’t wait for this night game. Too bad Bouba isn’t on the team anymore, the stripes are totally his style. (I feel bad just writing that… Bouba you’re unreal!)

Recovery update

New data out from the Commerce Department shows the trade deficit narrowed 6.7%. Even though oil was trading at the highest levels since September of ’08, the deficit was reduced to about $43.7 billion. While some of this has to do with imports from Japan dropping 25% with all the shit going on there, record exports are forcing many economists are now claiming they’ll revise the Q2 GDP growth rate. 1.8% was pretty hard to understand, so hopefully there’ll be a consensus on a higher rate. The deficit numbers also pushed stocks up about 1%, with the Dow up 75 points and the S&P up about 9 points. I wouldn’t expect those rises to continue tho if shitty numbers keep comin’ out.

New claims for unemployment benefits increased by 1,000, to 427,000 this past week, while forecasts expected that number to drop instead. I feel like that’s a big statistic, even if it was only 1,000 new claims. That means 1,000 more people we’re just like “fuck… might as well get paid to do nothing”. It’s hard to decipher what unemployment stats are actually saying about the economy, because we’re at a point now (and have been for awhile) where some people would rather take the unemployment checks than work at or near minimum wage. This is where my conservative side kicks in and I wanna fuckin’ trash the idea that we even have unemployment benefits… but I ain’t gonna hate. If I was 5-years out of a good college and there was no hope of a job except pumpin’ gas for $7.25 an hour, it’s possible I might do the same thing. Seems a little emasculating to me tho, prolly why some of those people have the balls to do something about their situation.

Deficit reduction talks are gonna start up soon. Interesting to see if the Dems can get the GOP to agree to some tax increases.

10-year yields down after Bernanke speech

Dopies Bill!

Bernanke mentioned in yesterday’s speech that further Fed action might be required. Basically, the recovery is slower than expected. Some sectors are growing while others remain stagnant, things are not that dopies right now, but should be getting more chron in the next two quarters. Today’s 10-year note auction produced a yield of 2.967. The drop also caused the May 10-years, which yield 3.125, to be pushed up 1/4 to 101 11/32. Justin Lederer of Cantor Fitzgerald said, “With the future uncertain, investors are grabbing as much yield as possible, even if we aren’t at amazing yield levels. The market is playing it safe right now.” Ya, that explains it. The bid-to-cover today was 3.23, above the average of 3.09.

Dogshit numbers over the past couple weeks have been dominating equities. The Dow closed 21.87 points lower than yesterday, at 12,048.90. The S&P fell another 5.38 points to 1,278, with a lot of people saying 1,200 could be a dangerous level and could prompt a sell-off. Let’s fuckin’ hope not. It’s gonna be interesting to see what happens when QE2 wraps up this month. The 2-year/30-year spread was down today to 3.83 from 3.85 yesterday, the high since March. The prospect of continued low interest rates has been pushing this spread as the economic data has supported continued Fed intervention. For clarification, people are continuing to buy more 2-years than 30-years on the hopes that QE will be extended and prices will go up, which widens that spread.