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.

 

 

Alan's Alert 7-8-2021

 

Another day, another labor report.  Unemployment insurance weekly claim reports were updated this morning by the Department of Labor.  Below are the charts for initial claims and continued claims;

Initial claims are continuing their trend lower.  Today’s report showed an increase in claims, but the trend is the key.  With initial claims at 373k, we are still 168k claims above where we were pre-pandemic.

Continued claims were reduced 145k to 3,339,000.  Again, well above the pre-pandemic baseline but continuing the trend lower.

In the DOL’s data release, we got a look at the change in those receiving pandemic related unemployment money.

Looking closely, you can see that 464,663 people have been removed from the pandemic unemployment benefits.  However, there are still over 10.7M on some form of pandemic related unemployment assistance.

 

In more broken record adventures, the FOMC released the minutes of their June meeting yesterday.  A lot of words were used but not a lot was said.  Members were surprised that the actual rise in inflation was larger than anticipated.  However, this did not set off any alarm bells.  In a repeat of the 1970s, the rise was attributed to supply constraints or bottlenecks and not monetary policy.  The word ‘bottleneck’ was used 8 times in their meeting minutes.  There was talk of reducing the number of mortgage-backed securities (MBS) and treasury bond purchases.  Ultimately, they kicked the can and stated that they would, “continue assessing the economy’s progress toward the Committee’s goals..”.  If one of those goals is full employment, the Fed will be behind the curve.  The disconnect in the labor market will be here until those 10.7 million Americans on the emergency pandemic relief join the labor force.  Unfortunately, the vast majority won’t leave the dole until the relief is ended in September.  By then, it will be too late for the Fed.

 

 

Yield Spread Check

The above chart shows the spread between the 10-year treasury interest rate and the 2-year rate.  The spread is well within positive territory with a difference of 115 basis points.  While there has been a sharp downturn since March, keep in mind that a recession generally does not hit until the spread is negative.

 

 

 

Alan’s Options Primer

Volume 2

Today is post 2 of 3 in my options primer series.  If you watched the videos, you’ll be ahead of the game today.  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.

 

Option contracts represent an agreement to exchange a specific number of shares of a particular stock, at a preset price, on an exact date.  The number of shares in a standard contract is 100.  The preset price is called the strike price.  The exact date is called the expiration date.  Unlike stocks, all option contracts expire.  This is one of the many reasons that it is very easy to lose money trading options.  Another thing to keep in mind, buying an option offers the right, but not the obligation to purchase (or sell) the underlying stock.  The vast majority of contracts that have value at expiry are settled in cash, not stock. 

 

There are two types of option contracts, calls and puts.  By purchasing a call contract, you are indicating that you want to purchase the underlying stock.  A put contract means the opposite, that you want to sell the underlying stock.  

 

Now, it is important to remember that a trade can move against you, making your options go down in value rapidly.  It’s vital to set mental limits on how much you are prepared to lose.  Not every trade is going to work out in your favor.  It is best to cut your losses and have enough ammo to fight another day.  Seeing a position down 50%, 80%, or 90% is mentally taxing and can negatively impact your future trades because you’ll think about “making up” the loss.

 

There are three primary factors that determine an option contract’s price.  They are; the price moves of the underlying stock (delta, gamma), time until expiry (theta), and volatility (vega).  These factors are given Greek letters because the pricing of option contracts is based on mathematical formulas.  The most popular of these formulas is the Black-Scholes model.    

 

 

Alan's Alert 7-7-2021

 

JOLTs (Job Openings and Labor Turnover Survey) data came out of the BLS (Bureau of Labor Statistics) today and we have a new record.  

Total nonfarm job openings have hit another record high.  At this pace, help wanted signs are going to be the next shortage.  The number of job openings in the US rose to 9.209 million.  Job openings increased in a number of industries with the largest gains recorded in services, followed by education and educational services.  Employers have been opening their businesses and searching for help but help is hard to find.  In fact, total nonfarm hires were down by 85,000 over the previous month.

In addition to the record high in job openings, we also have a new record in layoffs and discharges which have never been lower.  The labor market remains in a disconnect.  With many potential workers still getting emergency unemployment through the federal government, wages need to come up for them to be motivated to find work.  I find this to be another arrow in the ‘inflation is perpetual’ quiver.  As a reminder, here is a rundown where states have ended the pandemic related unemployment;

Something to keep in mind, this JOLTs data is from May.  None of the data related to the above states ending the emergency benefits have been reflected in this most recent report.

Alan’s Options Primer 

I had some interest in options trading and how it works.  I thought I’d put together a series and see how it goes.  I’m planning on breaking up this topic into 3 posts.  Today is post 1 of 3. 

 

I have only two rules when it comes to 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.

 

Options are highly volatile derivatives based on the underlying stock that the option contract represents.  You might not understand what this means yet but understand this, you can lose money very quickly with options.  Never buy options with money that you aren’t prepared to lose.

 

Now that we’ve gotten that out of the way, I would recommend viewing this video by Robert Shiller.  It is part of his recorded lectures on Financial Markets (ECON 252) at Yale.  He gives a great overview, history, and breakdown of option pricing formulas.

 

Another good resource is Option Alpha.  Their Beginner Course series on options is well put together.  As a disclaimer, I have not watched this entire series.  I’ve watched many of their videos and they do a great job explaining the ins-and-outs of options trading.

 

With these videos as a base, I’ll start to give my perspective and overview tomorrow.