The further a society drifts from the truth, the more it will hate those who speak it. ... In a time of deceit, telling the truth is a revolutionary act. George Orwell

Saturday, March 21, 2009

Playing the almost expired put options

Did anyone notice how cheap are some put options a few days from expiry? I don't think their price truly reflects the volatility, which makes them a viable game.

For example, 10$ strike put options against GE could have been bought for 0.14$ last week, at the time when GE stock price was 10.5-11$.

Interestingly, GE stock went down to 9.3$ on the day of expiry (last Friday) which made this a very lucrative play. This is not the first time that I noticed this phenomenon: in almost every case of my last 12 months option trading, the underlying stock almost always seemed to have experienced an unusually steep drop on the option expiry date (third Friday of a months, every third months for a given stock). Accidental?

As my friend Dozent says: every single conspiracy theory that we discussed in the past (except reptilian aliens 8-:) ) proved to be correct! I am curious!

Wednesday, March 18, 2009

US TBonds crashing?

What makes me think of that possibility?

Fekete's article:

... U.S. debt [1T$ in TBonds] in Chinese hands has no definable value: any time the Chinese want to sell a sizeable amount, all bids are withdrawn. The Chinese are stuck with it. They have to wait for their money until maturity. But who knows what the purchasing power of the dollar will then be? The best the Chinese can do is to “grin and bear it.” They can’t even say “ouch”, because this would further hasten the deterioration of marketability of their paper. The periodic warnings from China that the U.S. government should display greater fiscal responsibility and it should follow a stricter monetary regimen sound like whistling in the dark. ...

And this:

Fed to buy up to $300B long-term Treasury bonds

WASHINGTON (AP) -- The Federal Reserve announced Wednesday it will spend up to $300 billion over the next six months to buy long-term government bonds, a new step aimed at lifting the country out of recession by lowering rates on mortgages and other consumer debt. ...

Let me review some of the relevant events of the last months, chronologically:

1) Chinese gov is declaring a 600B$ stimulus for Chinese infrastructure

2) Chinese central bank is (probably) trying to sell some of their US TBonds discovering (probably) that they either cannot sell or that they have to discount them.

3) Chinese government officials complain to the US government and criticize US in public on the subject of the integrity of the foreign held paper assets issued by the US Treasury.

4) For the first time since the financial crisis begun, Federal Reserve is printing very large amount of cash (300B$) to buy TBonds on the market.

Why do I have a nagging suspicion that the events 2 and 4 may be somehow related? Is the Federal Reserve buying up the US TBonds that the Chinese bank was trying to sell on the market but couldn't? Note that buying TBond by Fed is equivalent of printing cash! 300B$ is probably 20-30% of the existing money (M1) in circulation.

Conclusions:

- this is highly inflationary, and is likely to counteract the current bank-bailout engineered deflationary credit squeeze.

- the old rule that the pre-mature resale value of the long bonds (but not short term bills) is supposed to be inversely proportional to the yield, no longer seems to apply or requires a large correction factor in the zero yield limit.

I suspect that the long term fixed income assets become illiquid or may even lose value once the yield goes below about 3% or so (at present). It's a case of a theory stretched and extrapolated beyond it's proven domain. Everyone assumed that since lowering the yields from 12% to 6% increased the money velocity in the past and increased credit supply, then lowering it from 3% down to 1.5% or from 0.5% to 0.25% is going to have a similar effect. I think what the present events have demonstrated is that the system is non-linear and that the money supply versus yield curve reverses below a certain yield threshold such as 6% (not sure of the exact figure, read also this - scroll down to the entry on Wed 2 July 2003 titled "What exactly is the relation between interest rates and inflation?" ). The result seems to be the opposite to the expected: forcing the Treasury yields below 3% seemed to have REDUCED the credit supply on the market and led to deflation!

Since everybody loves predictions, I have to finish on this note:

- if China could not easely sell their TBonds so will the US gov not be able to do so either, in the nearest future, forcing the US gov to print even more money than today's 300B$, counteracting deflation and eventually (probably) causing inflation.

- falling TBond resale prices on the open market will increase inflationary expectations and will force all the other new bonds to carry higher yields - despite the government's central banks declarations.

- large players, such as sovereign funds are likely to question the role of the dollar as the universal currency, to renumerate their assets in. The death of the US TBonds (if that happens) means also a death of the dollar!

P.S. (21/03)

I wrote it in the morning, later it was announced that the total sum is 1.2T$: 300B$ of new cash to buy US TBonds on the market and the rest to buy some other dodgy paper assets. That move is effectively doubling the money supply. I have seen that kind of economics in the People's Republic of Poland in the 1970-ties. I have seen the "future" and it did not work! Ask any Pole who lived through this period what a "virtual coal" was. 8-)

Wednesday, March 11, 2009

Market moves in such a way as to render the assets of the biggest players worth less!

Some of my thoughts, opinions and beliefs on where we are heading to.

Last 200 years of Western economy were split into stages in the following order:

- Land owners' oligarchy.

- Industrial oligarchy based on manufacturing and natural resources.

- Service based economy.

The current cycle that has just ended, was characterized by:

- Explosion of credit and debt backed by property and service sector stock used as backing assets (mostly the non-manufacturing and non-resource sectors).

Next stage that has just begun is characterized by:

- Implosion of credit and debt.

Similar as in the previous cycles, this unwinding will have to result in the wipeout of the assets of the most privileged class - the banking and financial elite! They have resisted it and will resist by various measures, most likely by:

- Propping up the collateral by supporting property values thought mortgage insurance corporation bailouts and by supporting the service sector stock, probably through various covert "plunge protection" schemes.

- Enacting mutual guarantees and support schemes for the financial assets; see for example the recent US government guaranteeing liabilities of various corporations.

- Direct recapitalization of financial institutions by government. This requires maintaining (an illusion of) low bonds yields to facilitate the debt issue. Note that this process does not eliminate the financial "nuclear bomb in the basement"! It only moves it from one "basement" to another. Obama's bailout for Wall Street bankers belongs in this category.

- Maintaining the currency value to protect the real assets' value. Note that this requires a disciplined approach that permits issuing of bonds to cover new debt but prohibits expanding the monetary supply (i.e. it precludes government or central bank from buying back their own bonds or bills for cash).

The above measures are characterized by the desire to protect the assets of the Elite but they do not address the real cause - debt! The problem is that although the value of the assets declined and was often marked-down, the nominal contractual value of debt was not declining and generally cannot be easily marked-down to market. If - when the above measures fail and the assets continue to fall, the next steps will probably be an attempt at neutralizing the debt to stave off the mass corporate bankruptcies. It may happen in the following order:

- Shifting of remaining liquidity (by elites) into hard assets such precious metals, land, natural resources, some save heaven countries and others that I cannot yet think of.

- Devaluation of Western currencies.

- Controlled inflation implemented by governments and central banks through buying back bonds with newly printed cash.

- Uncontrolled inflation by governments having to print cash to cover their operating costs, pay for the inevitable gigantic emergency social welfare and debt servicing expenses.

I am concerned that the above depicted scenario may be aggravated by certain common corporate-cultural issues, such as:

- Rewarding top executives for accomplishing some short term accounting goals to the detriment of the long term strategic planning.

- Over-reliance on dumbed-down hierarchy of hired management with only business degrees.

- Lack of accomplishment-based rewarding practices and too much tolerance towards an inactivity among the management ("job for life" disease).

- Tendency to expel skilled people from the workplaces through the top-down negative selection ("fish rotting from the head" syndrome).

Recommended relevant readings:
1) "Atlas Shrugged", Ayn Rand
2) "Social Collapse Best Practices", Dmitry Orlov

oh and a must watch:

3) "Clark Winter's interview, Bloomberg 10/03/2009" (scroll to minute 4 and after)

- one might also consider this (watch the last scene):

4) "Fight Club"
(before you watch the film, make sure you have a good anti-virus and pest patrol, do not click anything else) Update - I disabled the link (unsafe!), instead it is better to get a torrent from mininova.org (search for "Fight Club" title) and then download the full movie with a BitTorrent. Good luck.