The Nazis are all dead. America became the superpower. Islamists aren’t as scary as the first seemed geopolitically. Russia, while they have renewed their weapon base in the past several years, cannot be engaged because of the threat of nuclear war.
General Sherriff, in his most presumptive claims, thinks that next year “Russia, in order to escape what it believes to be encirclement by Nato, will seize territory in eastern Ukraine, open up a land corridor to Crimea and invade the Baltic states.” Furthermore, he was incensed that David Cameron had let the Uk become such a weak player on the international stage, as they no longer played a relevant role in EU security.
Sherriff is not the first to commit heinous presumptions like these, just this year both NATO and President Obama have lined up to name Russia as the greatest threat to peace and security in the region.
The US and NATO have encircled Russia in the past 30 years. Nuclear missiles and missile defense systems cover Eastern Europe for “protection.” The Cold War is long over, we must return to some semblance of peace, an acceptance of nuclear weapons, but a commitment to never using them. It sickens me to see what is happening now.
As such, Short US equities, Long Russian bonds. Short the Ruble.
One way to think about options is to think of them as insurance. People pay for insurance to protect against an adverse event. Similarly, options are bought when investors think the market will move significantly up or down.
Volatility, by definition, is both a measure of the dispersion of returns for a given security or index and the expected fluctuation of the return over a certain period of time. Simply put, volatility is a “fear gauge.” As volatility increases higher, so too does investors uncertainty about what future prices will be.
Like insurance, options too also require a “premium” to be paid. Just as a 50 year old will pay a higher premium than a 20 year old, so to an investor will pay more for a high volatility stock than a low volatility one.
Previous returns of an underlying are one way to gauge volatility, but additionally and more importantly, option prices reflect the implied volatility, the representation of the broader market’s expectation for market movement, of the underlying. The actual market movement can be quantified as realized volatility.
As volatility is a “fear gauge,” when markets begin to suffer heavily, prices for options can skyrocket. During this period, investors will pay dearly for downside protection using puts. Once the “fear” leaves and markets normalize, option prices will fall.
This is the reason that we advocate a short options selling strategy. By capitalizing on individuals fear of loss, put options can be sold when markets are in a state of high volatility. When market volatility returns to normal, option prices will lose value, simply because of the decreased expectations for where the underlying will go in the future. This “vol crush” allows the option seller to buy back the sold option for much less than what it was sold for without any of the other option pricing factors being taking into account.
A business, also known as an enterprise, is an entity that is involved in the provision of goods or services to other business or consumers. They can be large or small, diverse or distinct, and they can be run for profit or not. The many types of business don’t preclude though exactly what the goal of business is.
This more esoteric question is that I’ve been reading about in Aswath Damodaran’s Corporate Finance 4th Edition. As a student of Philosophy, I think this question is actually much deeper than it first seems. The reason for my investigations has been my desire to broaden my depth of market knowledge and trading ability away from short term technical trading (max 90 days) towards longer term trading to be taken place over a minimum of six months to several years.
In his first chapter, Damodaran starts with the quote “It’s all corporate finance” as his “unbiased view of the world.” The realm of finance is not just limited to large public companies or corporations. Rather, any entity, person or thing, which engages in commercial transactions falls under the subject of corporate finance. It is a discipline that every must learn to some degree, as it is the basis for our human system of trade.
As such, there are several common themes businesses share if they are to be successful. They must find investments that are good enough to put their resources in, use the right mixture of debt and equity to fund those investments, and return cash to the owners of the business in the case there are not any good businesses to invest into.
These three processes, called as the Principles of Investment, Financing and Dividends are comprised of several smaller aspects which guide owners, employees, and managers.
What interested me though was Damodaran’s opinion of what the “ultimate objective” of a business is. Using the principles above, there are several objectives that one could work towards, investing in the best opportunities, finding investment opportunities, returning the most amount of capital to the owners, issuing high dividends, maximizing debt to income, growth in any number of things (income stream, market share, dividends, etc). While all of these pursuits may have their own value, they are in effect, subservient to his conclusion of what the end goal should be. The reason being is that one goal must be given greater weight than any other, it must be the ultimate objective.
In order to find this goal, Damodaran stipulates that it must have these three characteristics:
It must be clear an unambiguous.
It comes with a timely measure that can be used to evaluate the success or failure of decisions.
It does not create costs for other entities or groups that erase firm-specific benefits and leave society worse off overall.
First, by making the ultimate objective clear and unambiguous, it allows for managers and other decision makers to come to rules that differ in various cases. Ambiguous objectives like “maximizing growth” can mean different things for different firms. For a tech company like Snapchat, this might be user base, even though that users base doesn’t generating any new revenue. While for an art gallery, growth might entail the number of interested parties in a single piece.
Second, the objective must allow for those decision makers to be judged by themselves. Goodwill can’t be measured (even though accountants try to do so) and neither can social good. While these altruistic benefits of running a company are an added benefit, they should not represent the core objective of the business.
Third, the objective has to be met at (reasonable) costs. And can be to any part of the firm or consumer. So, while a tobacco company might increase its market share by marketing to teenagers, the social costs of there decision will outweigh any benefits the shareholders might receive. Or if a company cuts wages in order to find the salary of a new CEO, the company will then in effect disenfranchise more than it provides to the new executive. Thus, costs must be kept in check or the firm will go bankrupt, morally if not financially.
Given these three characteristics, Damodaran goes on to state that there is only one objective that possesses all three of these preceding characteristics, that is, the ultimate objective for a business should be to maximize its value. More narrowly, the objective of the business should be to maximize its stock price.
But for whom should the company maximize value for? Should it be there shareholders? Or for the entire business to include its lenders and employees? In order to understand who or what value should be maximized for, its important to know how a modern company is comprised. A modern corporation has five entities that comprise it. These are:
General Public (Consumers)
The shareholders choose a manager to run the firm and its employees. That manager must decide which investments are best and what mixture of financing will suffice. Once the company generates cash, the manager must decide whether to reinvest that capital or to return it to his shareholders. He also must ensure that the lenders are paid back on time and no harm is done to them.
In a perfect world, the manager makes a good investment that brings new cashflow into the company. The shareholders are happy because they have made a good choice for who should run the company and benefit from that manager increasing the value of their investment. The lenders are happy because they are paid back in a timely matter. The firm’s employees enjoy their work and are happy with their wages. Finally, the social cost of the good or service being rendered is nonexistent. If all of these conditions are met, then the general public will see and understand the true value of this company and purchase the stock, driving its price up and repeating the cycle.
The last point is important, as Damodaran makes it clear that in an efficient and rational market, the observers of the company will always be able to rationally value it. As they trade the stock on the exchange, the last price traded will always represent the true value of the company at the present moment.
So in the best case scenario, the managers of the firm are egoless and are directly focused on making the company as valued as possible. They make no attempt to lie or distort the information about their company. Furthermore, their decisions produce no social costs or benefits. You can see this in the cart below.
Real life is not like this theory I’ve just presented. In reality, managers lie about company performance, employees can be unhappy with the wages they are paid, bondholders may not be paid, and shareholders might not be able to replace a bad CEO. Thus while this gives a framework for how a company should optimally be run, it by no means will do so.
In Pt.2 I’ll continue with the next discussion about value maximization and further go into Damodaran’s teaching.
Don’t understand the markets but want to try and take advantage of them?
Well you are in luck. All you need to do is listen to someone else. There are loads of people giving advice out there. They may have charts, systems, targets, but most of all, they are willing to tell you how to think.
Trading is psychological. You have to be able to look into your own self and see what is right for you.
Don’t look back, look in. Trade from the heart and keep your opinions to yourself.
I get a call from Matt yesterday, he was trading the ruble, and he was down… a lot. I chuckled. I’ve seen him down before and able to come back, but when you are in the moment, there is always a bit of irony in the situation.
After my shock, he says he’s waiting for oil to get CRUSHED. In just a few minutes, the market is going to sell and the ruble will skyrocket, paring all of his loses.
You can guess how this story ends. Matt got a margin call later from his broker and then he called it quits for the day and went and had a beer.
So what happened here? A few things actually….
First, he broke a cardinal rule of trading, he refused to define a loss. He had no stops, either mental or physical. Even though he may have been willing at first to get out of the trade, as it further went south, he would not liquidate the trade even though he had already taken the loses.
Second, he became locked in a specific belief about how the market was going to move. He told me he was just waiting for oil to get CRUSHED, which would send the ruble up. Any minute now, it was going to be slammed. As it happened though, oil was crushed, but not down. It skyrocketed almost 2%, sending the ruble even lower.
By defying these two rules, Matt set himself up for a pretty spectacular failure. At the end of the day though, it was a good lesson. Next time he will use stops and define limits for both himself and his trades.
The recent VIX in the Oil markets has been incredible. What a time to be a trader. Just yesterday OVX, the OIL VIX chart hit all time highs of 80. Never in the history of OVX has the oil markets been in such turmoil.
When markets have been closed, Matt and I have mainly been trading futures. The market volatility has allowed for some pretty impressive trades lately. However, the most of our attention has gone into the ruble. It’s been a fun time to trade recently. The ruble essentially acts as a lagging indicator of oil. Russia’s economy is deeply tied to oil prices and the massive currency collapse that’s taken place over the last year is directly attributable to the drop in oil prices. The inverse correlation between oil and ruble allow for massive expansion of currency reserves, construction and investment during the boom times. Now, after losing more than 50% of it’s value, the ruble is being defended against further declines in oil. The ruble has been trading in a nice channel lately, fluctuating between 76 and 80, making for some great trading.
Over this next week we will be in the final process of getting the fund in place. We’re really looking forward to start trading. Volatility is extremely high at the moment and it’s a options sellers paradise.
If there was ever a line that summed up life after the Great Financial Crisis, its Michael Shannon’s (Rick Carver) description of how he has had to survive in the wake of 2008.
The solution to the crisis was to bailout the winners, the banks, the insolvent government insurance companies, the top 1%. All of this at the expense of the taxpayers’ dime.
Other than the fraud that Carver commits, his poignant explanation surmising his entry in the world of foreclosures encapsulates the reality of our “new normal” economy. After the recession, there were no more houses to sell, only those to repossess. Carver was no longer able to find new homes to sell on and speculate on. He was left without a proper profession because of how the economy had been juiced up on housing. Looking for opportunity, it was his easiest way out.
Even though his job carried heavy emotional baggage, laden with the experiences of ripping someone out of their home, he did make a few good points. 1. Don’t get emotional about your house. It’s just a box. There are bigger boxes, smaller boxes, they are all the same. The most important part is how many you own. 2. The people who were being foreclosed upon took the loans from the bank themselves. While the bank may have been complicit in giving these people adjustable rate mortgages, it was the people themselves who signed on the line to take the money. They are no saints either.
In 2016, the ruble has skirted with all time lows as crude oil has collapsed, US and European sanctions have cut of lines to cheap credit, and inflation is pushing double digits. However, the rising price of gold could give the ruble a reprieve and even save the currency.
The yellow metal, whose price has risen almost 20% in the last few weeks, represents 13% of Russia’s total foreign exchange reserves. In 2015, Russia increased its reserves by 208.4 metric tons to 1415 metric tons total, a 17% increase. The total value at the end of December was around $48.6 when gold was trading at its six year lows of $1062. Now with the massive rise of gold since the end of 2015, the expected value of Russia’s reserves is around $61.8 billion.
Additionally, in this period, the US dollar has declined in price. The DXY, a geometrically weighted basket of six currencies, the euro, Japanese yen, British pound, Canadian dollar, Swedish krona and Swiss franc, has fallen almost 5% and shows no sign of bottoming out.
Thus, while oil is skirting with decade old lows and has severely impacted the value of the ruble, the rapid rise in gold may be able to help the Russian central bank stem off some of the pressure on its currency. In fact, the ruble has been gaining in value to the dollar in relation to the price of gold and if gold continues its upward spike, the ruble may be able to claw back some of its previous loses against the dollar.
While the ruble ultimately will be connected to the price of oil at the end of the day, Russia’s smart move to bolster its gold reserves over the past several years is finally paying off.
In what should be no surprise, Russian consumers have been snatching up iPhones and other electronic goods amid the ongoing slump in the ruble, according to Bloomberg Business.
Shoppers have been trying to purchase these high priced imported goods before their prices are readjusted to match the current value of the ruble to the dollar, which last week hit record lows of 85.
“We are facing a shortage of the simplest iPhone 6 model because of outperforming demand for it this month, especially in last two days when the ruble plunge gave an additional boost to sales,” said Maria Zaikina, a spokeswoman for Svyaznoy retailer, as reported by Bloomberg.
As the ruble becomes weaker, the relative price of imported goods in dollars goes down. In the past month, the ruble has declined 11% from 70 to 78, hitting lows of 85 on January 21.
The ongoing slump in the Russian ruble is directly attributable to the slump in oil prices, with energy representing more than 70% of its GDP. As the price of oil falls, which is denominated in dollars, so too does the amount of revenue pulled in by energy companies and the government. In order to meet current expenditure requirements, set in rubles, the currency must be devalued, however the by product of this is that imported goods such as the IPhone become more expensive in ruble terms.
I want to share with you today how I approached the recent slump in oil prices. I personally believe it’s a great time to buy, or at least catch a quick bounce before prices crash down again.
The question is then, how can we exploit this with options? Well there are a multitude of ways depending on the amount of risk you are willing to take on.
If you are very risk adverse, you would probably think your best bet is going to be ITM calls, ATM call spreads, or a calendar spread. However, the problem right now is that Implied volatility is extremely high across the energy sector. Option prices have risen because of the downward trend of the market. So in my opinion, its going to be a better opportunity to sell options, rather than buy them. This isn’t to say that buying options at this point is a bad idea, rather, because of the extended downward move, I would rather catch a bounce and the volatility crush.
Looking across the entire energy sector, I wanted to find stocks that fit the following criteria:
Price greater than $15
Bid/Ask spread no greater than .25
Volume of more than 500k shares a day (tight spreads are usually indicative of good liquidity).
From this I was able to find the following stocks fitting my initial criteria.
USO (High Volume and liquidity even though it’s priced at 8)
APC – E
COP – E
CVX – E
DVN – E
FTI – E
HES – E
NBL – E
OXY – E
PTEN – E
SE – E
VLO – E
XOM – E
I’ve written E next to most of the stocks to show that they are approaching earnings soon and I should not take them into account.
Now the following stocks are left.
BP, CLR, COG, CRZO, EOG, ETP, HFC, NFX
From here I can delve further into each stock and find out where I can sell options at a point where I am comfortable. I am using the same trading plan I have provided for you in the course.
Here are the trades I came up with.
BP – Short MAR 16 26/25 put spread or MAR 16 26/24 spread
IV is only at 46%, but that’s reasonable
Max profit 26/25 $260 Loss: $740
CRZO – Short Feb 15 17.5/15 put spread (ATM but worth it)
Max profit .95 Max Loss: 1.50
EOG – Short FEB 16 57/55 spread
Max profit .60 Max Loss: 1.40
NFX- Short 21/20 put spread (chosen for liquidity reasons)
Max profit .32 Max Loss: .68
These are all good and fine trades, but if you want to take a bit more risk, I would advocate buying OTM calls. Using USO because of its prices and liquidity, here are the two trades I like.
USO – OTM 11 Calls APR 16 (38.2% retracement)
Cost: .22 per
OTM 12 Calls APR 16 (roughly 50% retracement)
I chose 3 month DTE to give myself enough time and then did a simple fib retracement to give price levels of where I think the bounce could come up to.
So there you see how I did a simple search for options that I could use to catch a bounce in oil prices.