To Effect Change

January 20, 2010

Good morning. A fairly heavy down day last Friday, on option expiration Friday, took the SPY down .87 (or 1%) for the week. The VIX continued its move down, slightly, to finish the week down .2 at 17.9. You would have to go back over 18 months to find the VIX closing under 18; it appears that the market has become quite comfortable. One flaw in this comfort argument, however, is the continual upward sloping volatility curve as you go out in time. For instance, even with this morning’s strong sell-off, the implied volatility in the SPY February 115 calls is 15.2. Going out, the March 115’s are trading at 16.4, April’s at 17.2, Sept.’s at 18.6, and Dec at 18.8. The furthest out calls and puts, those are the puts we like to purchase in the PIP Program, are trading at a 21 implied volatility for December 2011.

Why is this? Everyone (some even make a living doing it) seems adept at assigning reasons as to why the market goes up and down or things are priced as they are. I will not be so bold, as most of those people seem to have no clue. This skew plainly states that, for some reason or reasons, the market is pricing a relatively small chance of a large move in the near term, with increasing chances of such a move going forward. We can opine on why that may be, elections later this year, chance of double dip, etc. but in fact no one really knows. I do know that it does make it difficult to do a lot of the normal spreads I like to do for my clients. Even entering the PIP is made somewhat difficult by this skew, I have no real desire to buy protective puts at a 21 volatility and then sell covered calls at a 15. I will do it if I think the market is a seriously good buy at its current level, but I do not get that feeling. The same goes for calendar spreads I normally like to do for my more aggressive clients, you would certainly rather get positive “edge” by, say, buying a 24 volatility and selling a 28 against it instead of the other way. Doing a spread with “negative” edge can still work, but it is much more imperative that the stock behave like you are predicting. It will change, however, to a more normal pattern at some point, if it does not and gets more pronounced we do have some strategies to take advantage of the skew should it get crazy.

So what is going on? Market was down over 100 last Friday, causing a lot of call options to go out worthless. Yesterday we were up 120, and now this morning we are down currently over 150. It is tough to trade, for sure. Last night IBM, up 2.36 on the day to 134.14 (eclipsing the high of 132.02 of August, 2000) came out with earnings that beat estimates (as is their custom) and the numbers were met with a tepid response and quotes from some that the stock had run up so fast that any further investment amounted to “dead money.” Today the stock is 129.67. Other overnight issues involved China (remember them, no matter how much we mess up they will bail us out even though they are an untrustworthy totalitarian country) putting some further restrictions on bank lending, housing starts dropping, and Morgan Stanley allocating 62% of revenue for employee pay (clearly telling all who will listen that corporations are not yet fixed). We have also had a couple of major banks report, such as Bank of America, disappointing due to costs related to paying back TARP money and consumer loan defaults. I guess some people without a job have trouble paying 25-40% credit card interest plus penalties. Go figure.

On the political front we have the surprising victory of Republican Scott Brown in Massachusetts, which will change the political landscape in Washington to some extent. It essentially gives the Republicans 41 Senators (if they remain unified), and deprives the Democrats of the automatic 60 votes necessary to stop a filibuster. I, for one, would like to see them have to actually do a filibuster instead of the sort of gentleman’s agreement they seem to have. Make a succession of people (like Jimmy Stewart in the movie) actually have to get up there and talk around the clock, maybe someone might say something worth writing about. The troubling thing is that the “people” seem to be on a mission to throw out everyone in office (maybe not a bad idea) without seeming regard to who is running. I am not a student of Scott Brown at all, but I have this feeling that more people voted against the Democrat Martha Coakley than really for Scott Brown. I also understand the “reasons” might include disappointment with the Democrats performance so far (I too am seriously disappointed), possibly issues with the health care issue (although every time that bill advanced the market seemed to cheer), or just a general “main street vs. anyone problem” which can be easily understood. I absolutely think the intellectual and maturity level of people being sent to Washington needs to be increased on both sides of the aisle, but the wait until the last minute vote against any incumbent even if the challenger is Kermit the Frog to me seems shortsighted.

The time to really effect change is in the primaries, where someone other than the usual political hack could actually be brought forward. Illinois has its primary next week, and I will bet (with recent news about the historic change in Massachusetts still ringing in people’s ears) that the turnout is way less that 30% and no real change is even available by general election time. Of course, we have a primary very far in advance of the general election (before any interest can be generated), we give the Cook County employees the day off for the election (giving whatever hack they support a huge turnout advantage), and we have early voting, giving political workers the ability to shuffle all kinds of people to the polls in areas where vacations are foreign and unemployment is rampant. Just once in my lifetime I would actually like to vote for someone I think is qualified and courageous, rather than voting against what I think is the greater of two evils. In Illinois that may be way too much to ask, and maybe that is what people felt in Massachusetts as they cast their ballots for this Brown fellow. The collective “we” have the power to make some real changes, but for some reason “we” would never support a third party candidate or someone from outside of what we all know is a totally corrupt system.

OK, how do we trade it? Well, the last few days you wanted to fade the day’s move on the close, meaning buy Friday night after the sell off and sell last night after the rally. That is not exactly the strategy most investors are willing or capable of, but it sure would have worked over the last few days. So here are the investment issues as they relate to retail people (my clients). No one is receiving any money for cash balances, here or at banks or from the Federal Government. Any attempt to increase this return, either by corporate paper or state or municipal paper, has us walking up the risk chain pretty fast for what we would be getting. The volatility skew has taken away, temporarily at least, any “edge” we might have in our normal option spreads, including (to a smaller extent) the PIP. Also, the market seems pretty fully valued, so we are less tempted to pile in spite of the negative “edge.” I continue to believe that we should remain long the banking sector, and those in the XLF position continue to see us grinding out some profits there. It has not really moved up at all yet, but the franchise the big bank cartel seems to have been granted (even with some special tax) to me seems like it will be incredibly profitable going forward if the economy improves at all.

Starting February 1^st we are shooting to be back on the airwaves  as “Stocks and Jocks” on 1240AM Chicago, as well as streaming on the internet at our same website, www.StocksAndJocks.net, where you will be able to access and download our shows as before. The show will air live from 5:30am to 7:00am, and will feature myself, Dr. J, Tom Shanahan, Kevin Riordan, Robin Spitalny, and other exciting guest experts. It will be great, and if the radio signal does not reach you the internet broadcast will be of very high quality. I invite you to “friend me” on Facebook, e-mail me with questions at StocksAndJocks@Live.com and stay tuned for for information as we arrange to create the best show for you, the listener!

Also, be sure to check out the new feature on PTI Securities’ website, a “What Our Brokers Are Watching” section with daily stock activity and market commentary. You are also cordially invited to attend a FREE online Protected Index Program Teleconference on February 3rd, 2010 from 6:00pm – 7:30pm CST. All you need to attend is a PC and phone and this session is free to you but you MUST register. This informative, no-pressure live session, hosted by my brother and PTI President, Dan Haugh, will outline the strategy that makes the PIP money management program so successful for our long-term clients. You will have the opportunity to ask questions and if you have attended before and need a refresher, we also invite you back.