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In a recent post ("Two Ways of Hedging Apple and Research In Motion"), we mentioned that Tim's bearish November post about Apple ("How Apple Became Japan") looked prescient. It looks even more prescient now after Apple's post-earnings tumble. In our post, we mentioned a few different hedges on Apple. Below is a quick update of how those hedges reacted as Apple dropped more than 12% on Thursday.
Low Implied Volatility For the S&P 500; Lower For SPY
On Wednesday, Bloomberg TV reporter Adam Johnson noted that, while the S&P 500 Volatility Index (VIX) is near a 6 year low, hovering near 12.5, the volatility measure of the SPDR S&P 500 index tracking ETF SPY is even lower — at about 5. Consequently, Johnson noted, puts on SPY were cheap. In the link in his tweet below, he suggests that long equity investors consider hedging now, with the market near five and a half year highs, and the price of downside protection cheap.
Here Are Your Cheap… and Cheaper Put Options bloom.bg/11SKE2K
—Adam Johnson (@AJInsight) January 24, 2013
Johnson suggested investors look at the at-the-money March SPY puts, which, as of Wednesday's close, would cost about 1.8% of position value.
Cheaper Ways to Hedge SPY
Adam Johnson is right that SPY puts are cheap now, but there are less expensive ways to hedge, over a longer time frame, depending on how much of a downside you are willing to risk. The screen captures below show the optimal puts* to hedge 100 shares of SPY against, respectively, a greater-than-10% drop, and a greater-than-15% drop between now and June.
Unlike the March expiration put Johnson mentioned, the optimal puts above would provide protection until late June.
Effect Of Low Volatility On SPY Collars
In a previous post ("Two Ways Of Hedging Apple and Research In Motion"), we saw an example of a security that was expensive to hedge with optimal puts, but had a negative hedging cost with an optimal collar: the cost of buying its expensive put options were more than offset, in that case, by the income from selling its expensive out-of-the-money calls. The opposite is the case with SPY today: its put options are cheap and its call options are cheap too, so the income from selling those call options doesn't reduce the already-low hedging cost much. The screen capture below shows an example of this, with an optimal collar on SPY using a 10% cap and a 15% threshold (i.e., an investor opening this collar would be willing to limit his potential upside between now and June to 10%, in order to reduce the cost of hedging against a greater-than-15% drop in SPY between now and then).
Given the low cost of SPY puts now, I doubt many investors would be willing to cap their upside at 10% over the next five months just to shave 20 basis points (0.20%) off of the cost of their downside protection, but I've included the optimal collar screen capture above for illustration purposes.
*Optimal puts
are the ones that will give you the level of protection you
want at the lowest possible cost. Portfolio Armor (available on the web and as an Apple iOS app),
uses an algorithm developed by a finance Ph.D to sort
through and analyze all of the available puts for your
stocks and ETFs, scanning for the optimal ones.
**Optimal collars are the ones that will give you the level of
protection you want at the lowest net cost, while not limiting your
potential upside by more than you specify. The extension to the
Portfolio Armor algorithm to find optimal collars was developed by a
post-doctoral fellow in the financial engineering department at
Princeton University. This capability is currently available on the web version of Portfolio Armor, and will be available soon as an in-app subscription for the iOS app.
The Decline of the "Blue Social Model"
Blogger and Bard College professor Walter Russell Meade has written for years about the decline of what he calls the Blue Social Model, the post-World War II economic structure built on unionized middle class jobs with generous wages in government at at oligopolistic private sector firms such as the old AT&T. Of course, those sorts of private sector middle class jobs have been disappearing for decades, so what Meade has focused on is the unsustainability of unionized public sector jobs, with the increasingly parlous finances of state and local governments. Professor Meade noted in a post last week that the New York Times now acknowledges the fragility of this model.
In that post, Meade quotes Thomas Edsall of the New York times:
Dozens of city and state public employee pension plans are on the verge of bankruptcy—or are actually bankrupt—from Rhode Island to California; in 2010, a survey of 126 state and local plans showed assets of $2.7 trillion and liabilities of $3.5 trillion, an $800 billion shortfall.
Meade concludes: "The reality of blue model decline is so obvious that nobody can ignore it any longer."
While watching the incredible exploits of Felix Baumgartner as he successfully broke the record for the highest free fall jump, I learned something, and that was there is a line of altitude once breached requires a human to where a pressure suit, and obviously oxygen, in order to stay alive. That is the Armstrong line.
This week the market powered metaphorically through that line, and like the human body, it will require extraordinary measures to maintain, and or rise from these levels.
My momentum based buy signal is overbought, showing a pretty large divergence on the daily, from the September peak, to this new high. There is not the same intensity. On the hourly, which I trade, I am getting chopped now on my signal line. This is a red flag for me.
My signal chops on consolidation and reversals. This looks like the latter. Eighty percent of the components of the S & P 500 are buys on my signals, and twenty percent of those are considered blowing off on my indicator. I am not screaming bear market here though, as I am convinced sometime this spring we will reach the Von Karmen line (Google it), and reach for those new highs.
I think the volatility play is over for now, the February to March expiry is not nearly as steep as January to February curve, and the last time we had a fall so steep in volatility, it rose 55% over the next two weeks (hat tip to Zero Hedge). I have been riding XIV, and now long VXX. Retracing some of the Vol calmness will pressure the broad markets.
I think gold, silver and the miners are ready. The cycle guys are saying we are swinging to participate in a multi month move, and I have/had buys on both metals. Miner ETF's are still chopping, but some individual stocks are buys. I am in NAK, AG, and NAK. Miners have totally decoupled from stocks, and am looking for some regression to the mean.
As an aside, I am doing a paid webinar on day trading XIV, a trade that I do a lot, and have had some very good success. If interested email me to get the details. The class will probably pay for itself on your first trading day.
Enjoy the rest of the long weekend. Bob
www.arum-geld-gold.blogspot.com [email protected] (e-mail)
Hey fellow Slopers,
Back in November, when Apple was about 40 points higher than it is now, Tim wrote what now looks like a prescient post about how the stock's best days were behind it ("How Apple Became Japan"). Here's how Tim concluded that post:
As for the stock price, I suspect it'll resemble the Nikkei chart found
way above, although perhaps not as dramatically. I imagine AAPL will be
in the low 400s next year and will meander around relatively trendlessly
for years to come. Its multi-thousand percent gain will be a part of
financial history, just like similar gains enjoyed many years ago by
RIMM, CSCO, and YHOO.
