Tag Archives: brazil

Betting Against Brazil? Get Paid To Limit Your Risk.

Summary According to data released Friday, Brazil’s economy has entered a recession. The country has been plagued by economic and political turmoil recently. The 2x inverse Brazil ETF BZQ had the highest potential return of any ETF in our universe on Friday. We present a way an investor can be positioned to capture BZQ’s potential return while getting paid to limit its downside risk. Dark Days For Dilma In a recent article about Donald Trump’s new development in Brazil (“Trump Hotel Goes Up, And His Latino Views Barely Raise Eyebrows”), the New York Times noted that, in an interview with the Brazilian magazine Vega last year, the real estate mogul was asked if he’d met with Dilma Rousseff. “No,” Trump replied, “who is he?” The Times informs readers not in on the joke that Ms. Rousseff is, of course, a woman, and the president of Brazil. But if Trump had asked that question to his Brazilian interviewers today, they might have answered that she is also possibly the least popular politician in the country. According to a Reuters article published earlier this month (“Brazil Leader’s Popularity Sinks in Political Crisis: Poll”), Rousseff had an 8% approval rating, in part due to the corruption scandal at the state-owned oil company Petrobras (NYSE: PBR ), which has prompted calls for her impeachment, and in part due to the “worst economic downturn in 25 years” in Brazil. Brazil Enters Recession Rousseff received more bad news on Friday, as official figures showed the Brazilian economy had contracted 1.9% in the second quarter, as reported by BBC News (“Brazil’s economy enters recession”). BBC News also reported that Brazil’s first quarter GDP had been revised downward to -0.7%, from an initial estimate of -0.2%. The official figures probably came as no surprise to Brazilians, as the BBC elaborated: Most people have already been feeling the economic downturn long before today’s figures were out. Unemployment has risen rabidly while inflation was over 12 months is running above 9% – twice the government’s target. More worryingly, analysts believe growth might not return until 2017. Gloomy Outlook From Goldman Sachs Monday brought more potential bad news for the Brazilian economy, as Goldman Sachs lowered its GDP forecast for China, which is Brazil’s largest export market (buying 19% of Brazil’s exports, per the CIA World Factbook ), as CNBC reported (“Goldman takes a knife to China GDP forecasts”): The bank on Monday marked down its 2016, 2017 and 2018 projections to 6.4 percent, 6.1 percent and 5.8 percent, respectively from 6.7 percent, 6.5 percent and 6.2 percent, previously. Government Ineffectiveness Economic weakness in its largest trading partner, combined with a recession at home, would be challenging for any government, let alone one whose leader’s approval ratings are in the single digits. But Brazil’s government showed a worrying sign of ineffectiveness recently, in a trial run for the much-anticipated 2016 Summer Olympics. The World Junior Rowing Championships, held earlier this summer in the same waters in Rio de Janeiro where next year’s Olympic rowing events will be held, were marred by pollution (AP via NY Post: “US rowing team has vomiting, diarrhea after event at filthy Brazil lake”), despite tests going back to March “showing dangerously high levels of viruses from sewage in all Olympic venues.” Investors may wonder how well a government that couldn’t keep the sewage out of its showcase city’s waters during an international athletic competition will be able to handle its current economic challenges. Betting Against Brazil Given Brazil’s current economic and political challenges, and its sensitivity to economic weakness in China, some investors may consider betting against Brazilian stocks. One way to do that would be by buying the ProShares UltraShort MSCI Capped ETF (NYSEARCA: BZQ ), which seeks results corresponding to twice the inverse of the performance of the MSCI Brazil 25/50 Index. That index , which is designed to measure broad-based equity performance in Brazil, includes among its top holdings several Brazilian stocks that also trade in the U.S.: in addition to Petrobras, it includes Itau Unibanco (NYSE: ITUB ), Banco Bradesco (NYSE: BBD ), and Vale (NYSE: VALE ). The “Capped” in the name of the ETF refers to a methodology the index uses to keep any one stock from dominating the index due to its market cap weighting. As of Friday, BZQ was 1st among ETFs and 32nd among all securities in Portfolio Armor ‘s daily ranking by potential return. Every trading day, Portfolio Armor uses an analysis of historical prices as well as option market sentiment to calculate potential returns, which are its high-end estimates of how a security might perform over the next six months. In a previous article (“Backtesting The Hedged Portfolio Method”), we went into a bit more detail about how we tested that ranking system, and tested the performance of hedged portfolios as well. When it creates hedged portfolios, Portfolio Armor is agnostic about whether a security is a stock, ETF, or inverse ETF. Instead, it goes by each security’s potential return, net of hedging costs. BZQ probably wouldn’t have made the cut on Friday, based on its net potential return, but investors who want to buy it as a bet against Brazil can use Portfolio Armor’s hedging tool to find an optimal hedge for it. Adding Downside Protection To BZQ One way to add downside protection is with an optimal collar. A detailed explanation of optimal collars is available here , but, to summarize, a collar is a strategy in which an investor buys a put option, which gives him the right to sell a security for a specified price (the strike price) before a specified date (the expiration date), and, at the same time, sells a call option, which gives another investor the right to buy the security from him at a higher strike price, by the same expiration date. The proceeds from selling the call option offset at least some of the cost of buying the put option. An optimal collar is a collar that will give you the level of protection you want at the lowest price, while not capping your possible upside by more than you specify. Since you are capping your possible upside when using a collar, it can make sense to set that cap at your estimate of the security’s potential return, so, in a bullish scenario, your security doesn’t get called away before you capture that potential return. Since we calculated a 13% potential return for BZQ, we’ll use that as our cap, but, if you feel that, based on the bad news out of Brazil, BZQ could go higher over the next six months, you could enter a higher number for the cap. The other piece of information we’ll need to input here, in addition to the ticker symbol and the number of shares to hedge, is the “threshold”: that’s our term for the maximum decline in the value of the position that an investor is willing to risk. Since that’s based on an individual’s risk tolerance, it will of course vary based on the risk tolerances of individual investors. For the purposes of this example, we’ll use 13% as the threshold as well as the cap. You could use this same process with different values, but, in general, the lower your cap percentage and the higher your threshold percentage, the less expensive it will be for you to hedge An Optimal Collar to Hedge BZQ This was the optimal collar, as of Friday’s close, to hedge 1000 shares of BZQ against a greater than 13% drop before mid-February, while capping the investor’s potential upside at 13%. As you can see in the first part of the image above, the cost of the put leg of this collar was $19,500, or 14.78% of position value. But as you can see below, the income generated from selling the call leg of the collar was $20,500, or 15.54% of position value. So the net cost of this optimal collar was negative, meaning an investor would have collected more for selling the calls than he paid for buying the puts. 1 Essentially, he would be getting paid to hedge. 1 To be conservative, this optimal collar shows the puts being purchased at their ask price, and the calls being sold at their bid price. In practice, an investor can often buy the puts for less (i.e., at some point between the bid and ask prices) and sell the calls for more (again, at some point between the bid and ask). So the actual cost of opening this collar would have likely been less (i.e., an investor would have likely collected more than $1000 when opening this hedge). Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

You Hedged Like We Suggested… Now What?

In my last article I said unless we could rally this summer we’d be in for tough times. I cited the sectors our firm was selling. And provided, for your due diligence, a suggestion for hedging with ETFs. Where does that lead us today? In my last article (August 12,) I wrote “Indeed, unless we can mount a rally in the next six to eight weeks, it may be a long cold winter that follows this long hot summer before we can get back to moving forward.” Those words may seem prophetic now but they were really nothing but common sense. When a plant grows bushy and full, it usually means it is healthy. When it grows straight and willowy, it usually indicates a problem of some sort. It’s the same with markets. As long as all sectors are moving along – at different speeds, of course, but still moving in the same direction – then things are likely to continue in that direction. But when some 20% of all stocks in the S&P 500 are down 10% or more, and most others are flat to a little down or a bit up, trouble is brewing. Yes, Apple, Amazon, Google and Netflix were still roaring ahead providing, because of their large market cap, an inaccurate picture of “the markets.” As a result of this dichotomy I wrote, “We’re reallocating our portfolio strategy to reflect what we believe to be the likelihood of a dull market that vacillates between heightened expectations and dashed expectations. That means lightening up on developing markets, energy, industrials, materials, utilities and even some technology firms.” That meant pretty much everything! I advocated buying a couple unique situations as well as “shares of ProShares UltraShort S&P 500 (NYSEARCA: SDS ), which moves inverse to the S&P 500 at double the rate of movement, as well as shares of the iPath S&P 500 VIX (NYSEARCA: VXX ), which is a reflection of the volatility I imagine we’ll be seeing more of in the coming weeks and months.” Via client and subscriber e-mail, we’ve since added shares of AdvisorShares Ranger Equity Bear ETF (NYSEARCA: HDGE ) to this mix. But our best purchase decision of 2 weeks ago was not as a hedge for our long positions but as an outright short on hubris and autocracy, shares of Direxion CSI 300 China A Shares (NYSEARCA: CHAD ). CHAD is an unleveraged short on the 300 largest and most liquid Chinese A Share companies. All of these hedges served their purpose, with VXX up more than 17% on Monday, August 24th, and CHAD up greater than 12% that day. What to do now? I wish I could tell you that we are covering or placing trailing stops under these marvelous hedges, taking our profits, and beginning to reinvest in fine, now cheap, companies. But I cannot. We are in fact using any bounces – and they will come; no market goes straight up or straight down – to sell. We’re doing so even if it means taking small losses on the long side. I simply don’t see a catalyst that will make this week-long crash a distant memory with the market marching inexorably higher. I see such a hope as unsustainable in the real world, the real world consisting of a collapsing Chinese economy (about which we have warned in numerous previous articles;) a Russia unable to sell its only “product” for more than it costs to produce it; an Iran bloated with the gift of tens of billions of dollars with which to foment terror; Brazil; a dithering Fed; Greece; and on and on. If you are thinking of buying something on any bounce, may I suggest that the above VXX, HDGE, SDS and CHAD might be fine choices to serve as a hedge for any long positions you choose to keep. And I do think you should keep some long positions. For us, the washed-out Big Energy firms are now looking very attractive, for instance. I’m not advocating selling everything. Indeed, I have written puts in our family and some client accounts on Apple. If it never gets put to us, we’ll enjoy the free money from those who think it will crash severely. And if it is put to us, I’m OK owning Apple at 10 times trailing, understated, earnings. We’re also adding to our energy exposure during this selloff – Royal Dutch Shell (RDS-B) for 12 times earnings and a 5.5% yield? I’m OK with waiting for it to recover. No fancy algorithms, no Fibonacci technicals, nothing complicated. Just good old-fashioned stock-picking with a very large hedged position, under which we’ll place trailing stops in what I hope will be the not too distant future. And, at this rate (not that I expect it to continue at this rate!) a full-blown bear market of a 20% or greater decline could be on us by mid-September! While we take a certain pride in having advised exiting most long sectors just 12 days ago and instead buying the short hedges above, the market will always make fools of those who rest on their laurels. We remain keenly focused on each day’s market action and look forward to responding to the best of our ability, come what may… _________________ Disclaimer: As Registered Investment Advisors, we believe it is essential to advise that we do not know your personal financial situation, so the information contained in this communiqué represents the opinions of the staff of Stanford Wealth Management, and should not be construed as “personalized” investment advice. Past performance is no guarantee of future results, rather an obvious statement but clearly too often unheeded judging by the number of investors who buy the current #1 mutual fund one year only to watch it plummet the following year. We encourage you to do your own due diligence on issues we discuss to see if they might be of value in your own investing. We take our responsibility to offer intelligent commentary seriously, but it should not be assumed that investing in any securities we are investing in will always be profitable. We do our best to get it right, and we “eat our own cooking,” but we could be wrong, hence our full disclosure as to whether we own or are buying the investments we write about. Disclosure: I am/we are long VXX, CHAD, SDS, HDGE. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Time To Short The VIX?

Summary Historically, we haven’t reached breakout status for the VIX. Many global factors are at play. This is possibly an economic event leading to longer periods of backwardation. The last week in volatility has been very exciting to say the least. The VIX Index logged the highest ever one week gain in percentage terms. Again, we immediately had the pundits out yelling short the VIX. I saw posts on Thursday around the web urging readers to short the VIX. Someday, this will end poorly for them and the people that heed their advice (Friday should have been a good sign). Below we will examine whether this really is a good opportunity to short in terms of risk verses reward. I am always analyzing my risk and reward in a trade. Once the reward begins to outweigh the risk, then I will begin planning my entrance. I believe risk and reward are currently the same. Essentially giving you a 50/50 chance of profiting right now. More to come on that later. Let’s start by reviewing the past month for the Proshares Ultra VIX Short-Term Futures ETF (NYSEARCA: UVXY ) and the VelocityShares Daily Inverse VIX Short-Term ETN (NASDAQ: XIV ). You can clearly see the effect of last week in the chart. Similarly here is a chart showing the front-month VIX futures contract. As you know (or should know), UVXY does not track the VIX Index, which is currently at 28. This is a large divergence from the front month futures contract. Remember futures trade independent of the market and the VIX Index. This, in my opinion, means that investors aren’t that concerned yet over a crash in the markets. U.S. economics continue to be neutral to positive. However, global economic fears are beginning to spillover. Just six months ago analysts were touting emerging markets, now look at them. For more on how UVXY profited during the 2008 and 2011 VIX events, check my library here on Seeking Alpha. UVXY will benefit from the current levels of backwardation if they can hold for a longer period of time. See below: (click to enlarge) Backwardation at 6.5% roughly means that UVXY will increase 13% in one month’s time if futures stay the exact same price, minus any fund fees. Now we know futures never stay the same, but this is just an easier way to think about contango and backwardation. Backwardation hit over 20% in 2011 and over 40% in 2008 (backtested). Backwardation is the only way UVXY will hold profits over longer periods of time. Again, check my library for articles on backwardation if you are unfamiliar with the term. Historical Numbers I know many of you are very excited about this spike. However, let’s compare this event to past events. Backwardation: (click to enlarge) At 6.5%, this puts backwardation higher than a normal political event. If you remember in my last article we discussed the differences between an economic and political event. This event, so far, is leaning towards an economic event. Economic events are usually much more drawn out. I told you earlier in the year I was looking for a backwardation event higher than 10%. I believe this could become that event. More about this in the conclusion. Futures Levels Futures levels directly impact UVXY. Here is a longer-term chart of those futures levels: Yes, futures are towards the higher end of what they have been over the past three years. However, this is nowhere near breakout status. Futures generally trade lower than the VIX Index during a spike. For reference however, here is the VIX Index dating back to 1990: Conclusion The best entry points in the VIX futures, for shorting UVXY or going long XIV, occur during periods of prolonged economic turmoil. Yes, we logged the highest ever one week rise (by percentage) in the VIX Index. However, I feel we still have room to rise. Those pundits that are shouting short the VIX may be right or may be wrong, that is not the point of this article. I like a lot of reward for the risk I am taking. I don’t see the VIX returning to 12 anytime soon. We are in a prolonged period of slower economic growth. Eventually that was going to catch up to valuations and the U.S. stock market. We have recessions in Brazil and Chile. We have slowing growth in China, which should be your biggest concern. The Greek drama is off the table for now but you still have a case of many countries within the Euro that have very high debt levels and growth that isn’t high enough to sustain it. Here in the U.S. we also have unsustainable debt levels but can print however much money we desire. Ultra low rates have helped lower the burden of interest payments but the lack of decent inflation has backed The Fed into a corner in regards to raising rates. A September rate hike would spook the markets. The fact we don’t see higher inflation even given the ultra low interest rates is a realization and confirmation of the slow growth era. For now, I will remain on the sidelines and hope conditions continue to worsen. If I miss the opportunity, I am certainly okay with that. My total VIX portfolio is up a healthy amount YTD and I am fine with locking in those gains instead of gambling it away. This is not to say that I am not salivating at the mouth for a chance to short the VIX. Here is what I am currently watching, in order of importance: The Fed (what’s going to happen with rates, I view any delay as a negative confirmation on the U.S. economy) Economic data out of China (can the government stop the decline this time?) U.S. employment data (weekly) Devaluation of the Yuan (will it continue?) Economics in South America Political/debt situation in Europe (Greece drama is on the back burner for now) I am not backing up the truck to short this spike. We may get a bounce in the U.S. next week but economic problems always take a while to resolve themselves. I would short the VIX with caution if you feel that is the right thing to do. Call spreads (more info on my blog), stop losses, and not jumping all in help to limit your risk/reward. Risk management is needed here, otherwise you are just gambling. I wish you the best this week and know that I will be following the situation and posting updates when needed. It will be an interesting week! Should conditions deteriorate even more, I might begin shopping for a small position. With school starting, I would only be looking for a more long-term position since I am busy during the day. I just need more reward for the current level of risk. Donate to my classroom! I am trying to create a 360 degree mathematics classroom. Much of the money I make here on Seeking Alpha is donated back into public education, something I really believe in. My students come from the highest area of poverty where I live. They are truly great students with a desire to better themselves. My job is to level the playing field and give them a chance to succeed. One tool I used last year at a different school was a 360 degree mathematics classroom. It is a great tool for math teachers. A lot of what I teach lays the foundation for financial literacy and success in post-secondary education. Here is the link if you would like to help fund my 360 degree boards. Use the code SPARK at checkout (until 8/27) and your donation will be matched 100% up to $100. Currently they are running another promotion from The Gates Foundation that will also match 100% up to $1,000 (which would be more than what is needed). That code is JUMPSTART but will only be available for a limited time. You can’t use both codes. All donations are tax deductible and will make an actual difference in the education of some great kids. We are getting close to funding. Thank you! Disclosure: I/we have no positions in any stocks mentioned, but may initiate a short position in UVXY over the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.