Blow-off tops everywhere

Everywhere I look this morning I see spikes in risk assets: copper, silver, oil, the pound, stocks, credit, etc.  Copper and oil are moving tick for tick in lock step at the moment. These really are all the same market.

I recently read about a strategy whereby a trader would start “trading campaigns” 25k to risk on very high payoff black swan events. If his first short-term options trade was a winner, he would do another with the proceeds, and if that trade also worked, one more, for a total of three trades. The math can actually be highly favorable for of such a strategy, since for a good timer, the payoff can be dozens of times the initial capital. All you need is one winning streak in 10 or so campaigns to come out way ahead. This trader had attempted 9 such campaigns, 7 of which were 100% losers, 1 of which was flat, and one of which was a 60-bagger. He had socked away the proceeds from the 60-bagger, and was still trading 25k at a time. I’m not saying I’ll adopt this method, but it makes a good point about humans’ tendency to underestimate and underprice the probability of large moves, as well as their irrational risk aversion when it comes to the possibility of losing 100% in any one trade.

About these ads

42 thoughts on “Blow-off tops everywhere

  1. Have you looked at GE Jan 11 2.5 puts?
    Those are like a 30 bagger if GE blows up by then.
    GE Capital’s loans are a joke.

  2. Wow. That’s really cheap for 18 months out. Graphite used to be all over the GE implosion trade.

    Actually, I was thinking about this kind of trade today: you could accumulate a basket of bankruptcy puts on various suspect companies, and if they’re cheap enough when you buy, just one hit out of 10 could make the idea a big winner. This summer would be the time to put it together.

  3. You should buy some. I think I own about 1000 contracts.
    What others would be good?
    Something with the same shitty portfolio but less government backing. Any candidates?

  4. The REITs. And Goldman 2011 puts are cheap for all strikes under 100.

    Then there’s consumer stuff like Tiffany, Macy’s, etc. I’m also partial to $35-40 puts on oil. Time is very cheap here b/c of the contango.

  5. OK I did a screen for contenders.
    Total assets > 50 * tangible book
    EBITDATTM / EV yield less than 5%
    Debt > 3 * market cap
    Interest coverage ratio MRQ < 1.5

    From lowest IRC ratio, this selects:
    MTLQQ *this can’t be shorted

    Every major airline is on the list!

  6. Nice work, thanks! Unfortunately, the options on most of those have already priced in a pretty fair chance of a goose egg. For black swan kind of odds, I think we need to target big cap stuff. Doesn’t have to be total bankruptcy either, just some modest new lows to make 10x+ on some of these high fliers like AAPL.

    March 2010 puts are a relatively cheap way to play a rapid re-test. If we are peaking now, I’d expect a re-test or breach by then, since you’d think the market would go down at least as fast as it has gone up.

  7. What’s interesting is that GE is in the same class as all those other awful, awful companies – yet it has very low IV!

  8. The question is, will the US Gov ever allow Government Sachs or GE to go bust? It’s more likely to see the EUR/USD at 2 or 3 than GE at $2.5 or GS a $10. What do you think?

    (still limited access to the net due to holidays, but the S&P 500 PUT at 1000 seems quite appealing to me :-) )

  9. Sure, but that doesn’t mean these stocks can’t flirt with zero first, or at least take enough of a bath to scare traders into bidding up deep OTM options. That’s another thing that’s so great about the black swan trades — it doesn’t take the actual event to make money, just a perceived increase in its odds.

    I heard Hugh Hendry say recently that he liked CDS on German sovereign debt, not because he thought there was a real chance of default, but just because he thought it would become a more common worry.

  10. Depends on what’s meaningful to you.

    If you put 0.5% of your money say in December 40 strike puts on oil (let’s say you pay $0.50 each) and it falls to 30, your portfolio goes up 10%.

  11. What I love about GE is how liquid the deep OTM options are, you don’t even get screwed on the bid/ask spread the way you would with a 2011 bankruptcy put on a lot of other individual equities.

  12. Two points about the GE options:

    1. Mike is right about the perceived increase in odds. As soon as we have a climate of sanity (not even fear) in the market, the IV will jump, meaning these options could increase in value by 5x. That could happen with GE down to only $8 or $9.

    2. Paj is right that the Feds won’t let anything happen to GE or GS IF they have a choice. But the Feds have backstopped a ludicrous amount of debt. They can’t really afford to make $600 billion of GE liabilities whole – it is a bluff. The bond market could call their bluff.

  13. Mike: how much would you pay ATM puts on the WTI and how much would you mike if oil goes to 30? 50?

    CBS, Mike: I think the GE/GS collapse trade might work but that the position would need to be closed quite early (as soon as the markets starts to really worry) because I’m pretty sure that since everybody is blaming the crash to the “failure to bailout lehman”, they wouldn’t do the “mistake” one more time and let anybody collapse.

    Also, you don’t need the US gov to take on debt, you would just need the Fed Reserve to come up with a STALFTBOGSAGE (Special Term Asset Liquidity Fund To Bail Out GS and GE) which would buy back all the bad debt of GS and GE at the “right price” (because of course, the market would be wrong to value those assets at 1cent on the dollar while the quants value them at 2$ on the $ :-) )

    what do you think?

  14. Yeah, nice tight spreads in the GE chain.

    The bond market will start to crack at some point, but I think it’ll continue to find support during this phase while other assets are collapsing quickly. So there’s still room for more bailouts, but even then, it seems to be the corporate bondholders who are saved (Pimco), not the common stockholders.

  15. I dunno exactly, Pej. Depends. Dec 50 puts are about 88 cents. June 45 strike is about 1.25. You should check for yourself in a good brokerage like Interactive Brokers or Think or Swim.

    I’m signing off. Need my zzz’s.

  16. Keep in mind, also, the kind of voter anger that accompanied the passage of the last TARP package. They barely managed to get it passed, and the Congress was flooded with angry calls & letters. If things start melting down again, there may be even more opposition and the political will may not exist to continue with unlimited bailouts.

  17. Guys .. is’nt the USD totally oversold? If the USD begins to rally … that will put downward pressure on commodities and the markets …

  18. Guys, with all this MASSIVE STIMULUS and MONEY PRINTING going on … would’nt this make the markets keep on going up … albeit a bit slower but still higher … more and more I am thinking that we could be in the beginning stages of that massive March 2003 – March 2004 rally …. I mean these guys can keep on printing money … there is nothing to stop them!

  19. No, credit is still contracting rapidly everywhere but China, and there I expect it to shut off before long and bring on a crash. The printing here has done nothing but keep zombie banks afloat.

    I agree with Boockvar that after the whole world crashes some more, Asia will actually decouple, but this is years away.

    Bullishness on gold has been tracking dollar bearishness, and both have been hovering at extremes for some weeks now. The chart patterns in the dollar and precious metals for the last few weeks look to me like their tops in 2008. It takes bearishness to set up blast-off rallies — the extreme bullishness lately puts a cap on gold and silver. The trade is just too crowded already.

  20. Hey Mike,

    One Yahoo finance now, by default they have added quotes for GOLD and OIL underneath the DOW, S&P, NDX quotes …. if that is a sign that Gold is going mainstream then does that not signal that the Gold bubble is about to take off to the upside … ?????

    So, would you agree that the USD is majorly oversold here??
    Damn, there are so many crosscurrents going on … I really think that the DOW will crash …. but relative to GOLD …. if GOLD goes to 2000 … then the DOW is cut in half no?

    The rules change after eery crash … by the time you figure it out … it’s going to be over, I mean the time we have left to trade ie … by 60 or 65 only a smapp portion of your assetts should be in risk etc … Making Money is NOT easy ….

  21. Mike,

    Regarding China, what percentage of new Chinese loans are going into things that wouldn’t be considered “malinvestments?” I do not expect an exact answer. I want to know your insight.

    Of course, the Chinese aren’t stupid, and I suppose they know they were going to write down some of those loans. Maybe this is a price for economic development.

  22. Aki, I don’t have a figure. I am no China expert. I just assume that they are being hit very hard by the collapse of their export markets, and that any supposed boom going on there now is just hot air due to infrastructure spending and speculation. The Chinese have in the past put an end to speculative madness with a simple decree that lending stop. The government must be very afraid of the combination of high inflation and high unemployment.

    From what I have heard, there is also a huge amount of new, unoccupied real estate is being carried at absurd levels, like a 1-2% cap rate.

  23. I suppose we are reading the same sources, such as Hugh Hendry, because I did like his insight on the renminbi/oil

    Mike, do you think this market is now a bear’s wet dream? Most of the shorts are now burned and it seems that people are going on the “better than expected” earnings trade now. Paradoxically, earnings can’t be “better than expected” if the market is pricing in/expecting “better than expected” earnings.

    BTW, is a large “value transferance class” an expected outcome of “meritocratic capitalism?”

    (That blog post was not written by a left-winger because in his blog, he supported McCain over Obama, but he didn’t like Ron Paul. I still find his description of social class accurate, and it is worth your time reading.)

    Any comments on that link?

  24. Something to digest…

    Technical market strength seen in resistance to repeated bear efforts since July 18; very low recent volume attributed to stocks in strong hands (“in the hands of interests not to be frightened by professional drives”). Recent rally having been digested, market considered in good technical shape for further advance.

    Market action still seen driven mostly by professionals, not much public or outside buying seen. Conservative observers still believe sustained uptrend unlikely until market breaks through previous resistance levels on good volume.

    When was this observation made?

    August 3, 1930

  25. Tim Knight posted this shot of dollar sentiment from EWI (I subscribe but I haven’t asked them for permission to do this like he has — they asked me if they could advertise here, but I don’t want to make this a business site):

    Now do you guys see what gives me such confidence in a big dollar rally and associated asset sell-off? When you see an extreme in price and an extreme in sentiment, fade that trade!

    I’m short the Euro, and pretty excited about it, but shorting any non-dollar, non-yen currency will do.

  26. Take a gander at that dollar chart. If it tracks down to the bottom of the channel (it looks like it should but if it did sentiment would reach sub-5% levels and it would be the mother of all longs, like the 3% bullish reading on stocks in early March). If it does that, expect total pandemonium as commodities make spike tops and for equities to keep running up on fumes for another week or two. That would likely mark the top of the wave 2 rally. On the other hand, if we turn now, we could still recoup for another run at new highs.

    No matter what happens in the next few days, a strong reversal within a few weeks is already baked into the cake.

  27. Mike,

    the worrying thing is apparently many people (I don’t know if it’s the majority or not) are not trusting this rally. If they actually happen to be the majority, then from a contrarian’s perspective it has still quite a long way to go.

    It’s not induced by improvement in economy, but by liquidity. Fundamentals… yes, they are horrific. But with horrific fundamentals, markets can still rally. Whatever the reason.

    All sorts of crazy things are taking shape. China is becoming a huge hedge fund, injecting liquidity (piling on debt) like nuts, hiding its NPL, buying up commodity oversupply at elevated prices, etc. Government Sachs, I guess many people know better than me.

    There are simply too many reasons for the market to go down right now: market structures (technicals), domestic fundamentals, foreign fundamentals (possible Europe-China blowup, especially), euphoria, and others. But it just keeps going up relentlessly.

    Now, in the face of this, shouldn’t we review our bearish views again? Perhaps the bull-market is real — for rather dark reasons, not economic health. Or… probably count me in as an additional bearish capitulation (LOL).

  28. Sure, a rally of this magnitude has momentum. I don’t expect it to drop right off a cliff, which is why I bought a few August calls when we were down 1% today (I just sold them a few min ago). Like I said above, if the dollar keeps dropping the market could keep drifting higher for another few days or couple of weeks, and some commodities could make moonshots. But my long term view remains the same — sentiment drives everything and theories about China and the Fed and Goldman driving prices up forever are just what would you would expect to emerge at a time like this, which is exactly when you want to put on your shorts.

  29. Hi all,

    just drop by and quite impressed with the work done by all of you guys here, anyway, just a few words to the market atmosphere.
    from what i perceived, the market is not totally bullish like all of you mentioned here, Bearish > Bullish (public), ‘coz there are still way too many derivatives (bear, put) bought by the general public which has a lot to say about the perception of the current economy, they have done so since the start of the rally. As you can see, many of them are broke, but they still keep doing it. We are almost there, but I dont think we are there yet probably need some more time to attract the majority of the people back to the game again.

    from Hong Kong

  30. Hi Ed. Thanks for dropping by. I agree, there is room for some more upside in risk assets if bonds and the dollar want to extend their declines into deep oversold territory, but the equity put/call ratio and Rydex mutual fund flows have reached levels that indicate public complacency. They are not stretched to extremes, but I consider it likely that we have a pullback from here or sideways action of at least several days. If it were my game, I’d be a seller of near-term calls here with a tight stop.

    Anyway, my own strategy centers around buying enough time with far-dated puts to let the market fizzle out on its own schedule. From that point of view, it’s an attractive short at these levels.

  31. Hi Mike, I agree with you on the indication of public complacency here. I also sense that from the mid of July after the turn around of DOW and the world’s market. Equity put/call ratio and Rydex mutual fund flows we would consider it a higher tier of investors in our market, the even superior one will be the Warrants and Callable bull/bear Contract that’s sold to the general public, which gives a better indication of how the market perceives about the rally. I’m also waiting for that specific moment, I’m bullish since March, and still bullish at this moment. Hopefully I will be able to pull myself out from the crowds later.
    from a technical, fundamental pt of view, we should definitely jump off the cliff, the thing is there are just way too much money out there, especially in our market, funds just keep coming in (non-stop). Im looking forward for a small pullback, and the resumption of the uptrend again. summer is definitely not a good time for bears.

  32. sorry, just a correction.

    the even superior ( i meant inferior, :) ) one will be the Warrants and Callable bull/bear Contract that’s sold to the general public

  33. CBS et all:

    You have to see this story re AXL:

    American Axle and Manufacturing Holdings Inc., up $1.14 at $3.75

    The auto supplier’s second-quarter loss shrunk in half from a year ago — but so did its sales due to Detroit automakers’ plant shutdowns.;.v=2

    Makes a lot of sense …. btw CBS, what software did you use to generate that list of companies???

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Connecting to %s