TTI’s Short Hedges
Since my previous post on Dutech (Dutech Holdings FY17’s AGM), the company has released it’s FY18Q1 results and I’ve had time to peruse it. I feel pretty much vindicated, although the headline news don’t quite describe it as such. Anyway, maybe I’d write about some new findings in the next post.
Of late, markets have been on a tear. US earnings season is well underway and in fact, near completion. Judging from how the S&P index has been performing, it seems like the general consensus is that good times are back, and that the earnings thus far, have met the market’s expectations.
My US options and equity portfolio have also done immensely well the past couple of months. Too well, in fact. I get cautious when things rise too fast, too soon.
I don’t know exactly how well is well, but I withdrew $50k USD from the US portfolio to put into the bond markets, after taking profit on some positions such as CTL and CHK.
Yet, today, the net liquidation value (As calculated by Interactive Brokers), is basically the same as before I did the withdrawal. So the gains in the past month++ or so must’ve equaled this $50k USD.
I’ve since swung to the slightly bearish side, and loaded up with some protective shorts as hedges. So where do we stand right now?
This is the S&P chart YTD:
Personally, I don’t think we’d ever see or cross the high (circled out in red) of 2,872 reached in end Jan. I don’t even think we’d cross the other high (2nd circle in red) of 2,786, although that seems more probable.
In just under a month from now, the Fed meets again, and it’s pretty much expected that the Fed will raise interest rates again from the current 1.75%, to 2%.
Not too long ago, as the Fed was loosening and pumping liquidity into the system, the excess liquidity pulled global markets from the brink of depression. Now that we are doing the reverse…… the same massive force that was at our backs, will now be in our faces.
This is the financial equivalent of Newton’s Third Law.
Ah, it took me sometime to find this link, I knew I just watched this not too long ago.
This pretty much sums up what I feel are the likely risks ahead. Of the few US companies that I followed closely enough, the earnings season wasn’t that fantastic. Not sure why everything seems to be rallying of late.
The “punch in the face” is coming, and it’d hurt no matter how forewarned you are. In fact, the markets probably pre-empt is all, as treasury yields have risen, bond yields have risen and the yield curve has flattened of late. All of which hints of tightening conditions.
I’ve chosen to add on protective short hedges via what I think, is a creative sorta way.
I’ve sold far OTM call options on the SPY, and used the premiums to partially pay for some of the put options that I’ve bought.
I’ve also gone nett long on volatility, by loading up on VXX, and at the same time, selling far OTM call options on these same VXX positions. The rationale is that volatility can spike up and I’d make a lot of money from these positions, but I don’t think we’re going into a great depression and volatility will go absolutely crazy. If it does, I’d end up forgoing the largest portion of profits, but will still sit pretty with a sizable profit.
I prefer to add on to the positions gradually over multiple days, and only add on a small 3 lot position each time. The above is just a small snapshot, the actual list is quite a fair bit longer.
In short (pun intended!), I really wouldn’t be complaining too much if the markets start turning south right about now.
I think my previous experiences dealing with volatility derivatives, and some new found insight, made me somewhat confident of building up these short hedges.
Another reason for going long VXX right now, is that of late, there’s been a divergence between the fortunes of SPY and VXX. The “fear index” doesn’t seem very indicative recently.
For many days in the past fortnight or so, whenever the SPY drops, VIX drops along with it, instead of rising.
Now, since VIX is calculated based on prices of S&P options, I’d expect some form of correlation. As it turns out, they ARE fairly well inversely correlated, as this table shows:
Although this correlation is imperfect, the odds are pretty much in the favor of an inverse relationship:
When S&P move down, VIX moves up in 78.40% of the instances, which is pretty well inversely correlated.
Yet, the recent breakdown of this inverse correlation that I’ve noticed in the past couple of weeks, indicates to me that something must change soon.
Either the VIX must start moving up very strongly when the S&P is down, or the S&P must start moving up dramatically (less preferred for me).
Since we’ve seen earlier that S&P has already been trending upwards strongly in the past week, I’d think that the odds are in my favor that the S&P starts coming down, and VIX starts moving up again (there’s a 78.40% chance that that happens)
And since I’ve pretty much been observing the scenario of S&P and VIX moving in tandem, which is only a 21.6% probable scenario, it seems logical to bet on the 78.40% scenario coming back pretty soon.
So let’s see what happens from here.