Alan's Alert 7-9-2021

 

Happy Friday everybody!  Yesterday the Fed dropped the data on consumer spending.  While the financial media heralded the return of the American consumer, the reality is less appealing. 

 

The US consumer's revolving credit (think credit cards) is still well below the trend while total non-revolving (think car and student loans) never broke trend.  For the Wall Street Journal to say that “borrowing is back” is an exaggeration.  It’s obvious to me that some consumers paid down credit cards with their stimulus payments, others stuffed it in their bank account.  I anticipate that it will take much longer for credit cards to come back to the trend.

 

Wholesale inventories were posted by the US Census Bureau today.  They increased 1.3% month-over-month in May.  Inventories increased for durable goods (1.2% vs .07% in April), especially lumber (7.6% vs 1.5%), metals (2.4% vs 2.3%), and furniture (2.4% vs 2.5%).  Non-durable goods were also higher (1.5% vs 1.7%), specifically drugs (2.3% vs -0.2%).  Its good to know that merchants are trying to keep their shelves stocked but the inventory/sales ratio continues to plummet.

This is not the lowest the ratio has been but we are getting very close to that number.  This is being exacerbated by the port slowdowns, workers staying home, and consumers with stimulus money burning a hole in their pocket.

 

Is there a quiet cold war going on between the US and China?  Some interesting developments have been happening over the past week that I think need to be reviewed.  On July 5, China’s Communist Party (CCP) celebrated their centenary, which is the 100^th anniversary of communist rule in China.  President Xi gave a big speech about how great China is and how China will not be bullied on the world stage.  He stated how China will be moving forward to more greatness in the future.  Prior to the centenary, a company in China named DiDi (which is hailed as the “Uber of China”) had an initial public offering (IPO) on the New York Stock Exchange (NYSE).  This gave investors their first shot at owning a share of DiDi.  It isn’t unusual for Chinese companies to get listed on the NYSE.  In fact, 36 Chinese companies have gone public on the NYSE this year alone, raising $12.6 billion.  What is unusual is that China suspended all new user registrations for DiDi’s app two days after the IPO.  By July 4^th, the app was ordered to be removed from all of China’s mobile app stores.  On July 7^th, DiDi had been fined by China’s State Administration for Market Regulation.  Less than a week after the DiDi debacle, two more Chinese firms who were going to list on the NYSE have pulled out.  It seems China deems data collected from social media to be a national security threat.  Now today, the Biden administration has blacklisted 23 Chinese based companies.  This tit-for-tat relentless retaliation is terrible policy and could spiral out of control in a hurry.  In addition to this, we are still dealing with Chinese ports running more than 16 days behind schedule and at 40% capacity.

 

This is something to watch closely.  If there is continued arrogant behavior from both sides of this equation, things could get out of hand quickly.  Serious market distortions could begin to develop.  We could swiftly move from quiet cold war to cold war to hot war.  This would put the kibosh on the stock market as all future expectations would be called into question.  Our least favorite superhero, the Fed, would be riding to the rescue by pumping ever great funds into the market to try to keep it afloat.

 

 

Alan’s Options Primer

Volume 3

Today is post 3 of 3 in my options primer series.  Yesterday I went over some of the basics of options like the number of shares in a standard contract (100), what a strike price is, and that all options have an expiration date (like milk).  I also went over the three primary factors that calculate the price of an option contract (delta/gamma, theta, and vega) and that they are calculated in a formula (Black-Scholes).  As a reminder, I only have two rules when trading options.  They are hard to follow but there is only two of them.  My first rule of trading options, do not trade options.  My second rule of trading options, DO NOT TRADE OPTIONS.

 

Something to keep in mind; when trading options and securities in the stock market, there is always someone on the other side of your trade.  You cannot buy a stock (or option) unless there is someone on the other side of the trade selling you the stock (or option).  Liquidity is important.  This is why big-wig investors like Howard Marks at OakTree Capital would spend a whole letter to his clients talking about it.  Options and stocks with low liquidity will be difficult to purchase and even more difficult to sell.

 

Let’s define the terms. 

Delta; in theory delta represents how much the price of an option will move in relation to each $1 movement in the price of the underlying asset. 

Gamma; gamma value represents the theoretical movement of the delta value as the price of the underlying security moves. 

This might sound complex, so let’s have an example.  Imagine you bought a call option with a delta of .60.  If the price of the underlying security rises by $1, then the price of the call option would rise by $.60.  If the gamma value was .10, then the delta would increase to .70.  This means that another $1 rise in the price of the underlying security would result in the price of the option increasing by $.70, and delta would also increase again in accordance with gamma.

Theta; also know as theta decay or time decay.  Options are time sensitive because they expire.  Theta represents the change in the price as the option’s expiration date gets closer.  Here is a graph to demonstrate what it looks like:

As the option contract gets closer to expiration, theta decay increases.  When there is less than 30 days left, decay is at its maximum.

Vega; is the value that indicates the rate at which the price of the option will change in relation to changes in the volatility of the underlying security.  This can be a hard topic to understand which is why it is vital.  Vega is the weak link in the Black-Scholes formula.  I will always look at volatility, especially implied volatility (IV), prior to any option contract purchase.  The reason vega is so difficult to understand is that you need to have an understating of volatility and implied volatility.  Neither of these are simple subjects and could be a whole post in their own right.  To keep it as simple as possible, the higher the implied volatility (IV) of a security, the higher the cost of the option contract.  I use the think-or-swim platform by TDAmeritrade to analyze IV before any option contract purchase or sale.

 

This concludes my primer on options.  Future posts on options will go over basic strategies and some examples.

 

 

 

Before I leave you to your weekend, if you find yourself kicking back without entertainment, I recommend a listen to Eric Peters, the Chief Investment Officer of One River Management, on the MacroVoices podcast.  While I don’t find his bitcoin thesis appealing, his discussion of inflation is spot on and worth a listen.