Tag Archives: etf-long-short-ideas

Shorting Volatility Has Never Looked This Good

I wrote an article last week about shorting VXX but that turned out to be a bad idea. But given what has transpired in the markets since then, shorting volatility has never looked this favorable. An oversold market and historically strong VIX and VVIX rallies means volatility is extremely overbought and due for a move down. Last Friday I wrote an article about one of my favorite trading vehicles, the short term VIX ETF VXX (NYSEARCA: VXX ). I said at the time that with volatility spiking on the short end that history suggested that it was a good time to short VXX. When short volatility spikes VXX outperforms but that condition is always temporary. I also warned against further moves higher in VXX as it is a high risk/high reward strategy that can be gut-wrenching to endure. Well, we all know what has happened in the last couple of days and shorting VXX was a big mistake. But since the situation has materially changed since Friday’s pre-market, I feel a new look at the trade is warranted because there are now more compelling reasons to stick with the short and/or add to the position. My original idea was based solely on the fact that the VIX had spiked on the front end late last week as China began to dominate the headlines. The US market (NYSEARCA: SPY ) hadn’t yet seriously deteriorated and I incorrectly thought we had another run-of-the-mill mid-20s spike in the VIX on our hands, setting up a great short for VXX. Obviously, I was wrong and my short position on VXX has lost roughly 25% of its value in the last two days. So what has changed? The first and most obvious answer to that question is that VIX (and VXX) has continued to spike. The VIX has put on an impressive and in fact, historic rally in the last few trading days. Here’s a five year chart of the VIX; you can really appreciate the magnitude of the rally we’ve seen in the past few days when viewing it in historical context. (click to enlarge) One of the things that has changed since my original trade idea is that the VIX is heavily overbought. The VIX rarely reaches overbought on the 14 day RSI because it tends to spike and fall instead of rally. We’ve seen a rally in the last few days and that has sent VIX’ 14 day RSI to 89. That’s an extremely overbought level and that is one reason I think the short VXX trade is still a good idea. As VIX moderates we’ll see VXX move down. Whenever we’ve seen this kind of overbought condition in the VIX in the past five years we’ve seen it move sharply down over the ensuing days and weeks so there is no reason to think that won’t happen this time. The second condition that has changed since my last article is that the broader market is now oversold as well. Here is a similar five year chart of the SPY to show what I mean. (click to enlarge) We can see that the MACD and RSI are showing extreme oversold conditions that mirror only those of the late 2011 tantrum the market threw. Of course, after that subsided, we moved substantially higher. I don’t know that we’ll move substantially higher in the SPY but we don’t need that to happen for the short VXX trade to work out; we just need it to stop going down. Given the condition the market is in right now we are certainly due for a bounce. Third, the volatility of the VIX index, or VVIX, has also spiked to historical highs. Consider the events that have occurred in the past 10 years with the financial crisis being one of them and then ask yourself if today’s events are more concerning; I think the answer to that is a resounding ‘no’ so that makes the action in the VVIX even more perplexing. Here’s a five year chart of the VVIX to illustrate my point. The VVIX actually exceeded 200 during yesterday’s action, a number that has never been reached before. Even recent panics in the market have caused VVIX to spike to the 120 or 130 area so cresting 200 is quite extraordinary. That tells me there is excessive panic in the market and that condition cannot persist. By definition, panic is temporary. Given all of this and the original trade idea that VXX cannot stay elevated forever, I think the evidence that VXX should fall in the coming days or weeks is quite compelling. We have a VIX and VVIX that are both extremely overbought after historical rallies and a broader market that is begging to rally. I don’t know if we’ll retake the highs on the SPY this year but as I said, we don’t need that to happen for short VXX to work. The panic will subside at some point and VXX will tank again; it always does. The ride to get there is bumpy and stomach-churning but the rewards can be great. Please understand that despite how good the setup looks a short VXX can still go wrong in a hurry – as we’ve seen since I recommended it on Friday – but the odds of a favorable result are exponentially higher now than they were on Friday. I just wish I had waited. Disclosure: I am/we are short VXX. (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.

SCHH: Finally The REIT Indexes Are Going Back On Sale; Limit Order Placed

Summary SCHH is trading lower at the same time as treasury yields are falling. When SCHH falls under $38.00 per share, I become interested in buying more. As of my writing I have a buy limit order in place for my personal accounts. I would like to see less SPG in the portfolio to improve diversification, however the rest of the portfolio is beautifully diversified. The Schwab U.S. REIT ETF (NYSEARCA: SCHH ), also known as “Schwab Strategic Trust” on Google, fell today (August 6th, 2015) in early trading and was down by .78% within the first couple hours. The drop in SCHH is interesting because it came while treasury yields were falling. When treasury yields are weak, income investors are more inclined to take on the risks of investing in an equity REIT index to achieve higher yields. As an investor, I love equity REIT indexes and I am long SCHH and the Vanguard REIT Index ETF (NYSEARCA: VNQ ) in my retirement accounts. Why Both? The first equity REIT index that really attracted me was VNQ and I began buying into it. Since then I began the process of moving my brokerage over to Charles Schwab and have free trading on SCHH which makes it more desirable for new allocations. Buying Strategy If I were to simplify my views on SCHH as far as possible it would be like this: Under $38.00 SCHH is a solid deal. The lower it goes, the better the deal. Seeing SCHH fall under $38.00 I decided to place some limit buy orders on SCHH. Since the ETF is so thoroughly diversified (within equity REITs), I’m confident about the underlying fundamentals of the fund. Even though I’m already heavily invested in SCHH and VNQ, I view price drops as favorable because I’m holding some cash and looking to buy more every time the price falls. I got lucky enough to buy in late June when prices were hitting at least a temporary bottom. I would love to say it was pure skill in timing the recovery, but that is absurd. I got home from a vacation, saw cheap shares, and put in a limit buy order. Holdings The holdings are shown in the chart below: (click to enlarge) There is only one meaningful concern I have about buying into SCHH. I feel that their allocation to Simon Property Group (NYSE: SPG ) is simply too large. It hurts the diversification of the portfolio to have 10% invested into a single equity REIT. Regardless of how the portfolio managers feel about this allocation, I don’t like it. I would rather see this allocation dropped to around 5%. Retail REITs The largest sector holding for SCHH is the retail REIT sector. My preferred part of the equity REIT market is the residential REITs, but when it comes down to building a portfolio the diversification into the different parts of the REIT market offer superior risk adjusted returns over the long haul. Simon Property Group I have no current business relationships with Simon Property Group. However, quite a while ago I ended a business relationship with one of their properties. I ended that relationship for two reasons. One is that I was moving farther away from the location and the other is that their system was not friendly to those leasing property. When I was dealing with one of their leasing managers they were too focused on establishing rental rates and sales expectations on a “per square foot” metric. That was a problem because they were offering breaks on expectations for leasing larger amounts of space which turned into breaks for customers were willing to play the game by adjusting square foot usage through building taller displays. The spaces I was leasing were adjacent to customer traffic pathways and were otherwise nearly useless due to how small they were. Of course, my experience is only that of one customer dealing with the leasing manager for one mall. However, getting a feel for the way the leasing business was structured left me feeling concerned that the strategy was less than optimal. Dividend Yield The dividend yield on SCHH is only 2.27% which is incredibly low for an equity REIT index. With reasonably similar holdings VNQ is offering a 3.89% dividend yield. Because the holdings are very similar, I consider SCHH and VNQ to be very comparable when placed inside a tax advantaged retirement account with no plans to withdraw in the next couple decades. On the other hand, if an investor was living off the dividends they would have a solid reason for preferring VNQ over SCHH. If Prices Fall Further The more prices fall, the more limit buy orders I plan to place. My retirement accounts right now contain a meaningful allocation of cash. The return on cash and equivalents is terrible, but I’m holding the cash so I can look for some bargain prices on my favorite investments. If prices fell as low as $36 or $35 my cash position would be mostly gone as I would keep going back to get more shares. Max Allocation Many investors appear to think (judging from comments on my articles) that allocating more than 20% of a portfolio to domestic equity REITs is too heavy. I’m willing to see my allocations go as high as around 40% on domestic equity REIT indexes. The volatility on a diversified REIT index like SCHH is fairly reasonable when compared to other major investments like total stock market indexes or the S&P 500. Due to moderate levels of correlation, the total risk level on the equity portion of the portfolio can often improve as allocations move up towards 40% to 50%. Note that this is referring only to allocation within the equity portion of the portfolio. Clearly replacing cash or high quality short duration bond funds with SCHH or VNQ will result in more portfolio risk. Conclusion I love SCHH as an investment vehicle. I’m long both SCHH and VNQ and I have a buy limit order on SCHH at $37.85. Disclosure: I am/we are long SCHH. (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. Additional disclosure: Information in this article represents the opinion of the analyst. All statements are represented as opinions, rather than facts, and should not be construed as advice to buy or sell a security. Ratings of “outperform” and “underperform” reflect the analyst’s estimation of a divergence between the market value for a security and the price that would be appropriate given the potential for risks and returns relative to other securities. The analyst does not know your particular objectives for returns or constraints upon investing. All investors are encouraged to do their own research before making any investment decision. Information is regularly obtained from Yahoo Finance, Google Finance, and SEC Database. If Yahoo, Google, or the SEC database contained faulty or old information it could be incorporated into my analysis.

MUB: Is This Large ETF A Safe Haven During Rising Rates?

Summary This is the largest muni ETF in the marketplace with a tremendous amount of institutional assets. Will they stay put with rising rates? What is the exposure for the long end of the yield curve and various states? We answer these questions and provide our recommendation on whether it is worth the risk. The iShares National AMT-Free Muni Bond ETF, MUB , is the largest muni ETF in the marketplace. Since the beginning of the year over $700 million in new assets have been added. With all of the bonds rated investment grade or equivalent, we decided to analyze this ETF to determine if it would be a safe haven, if and when interest rates move higher. We also wanted to determine what exposure there is to recent public pension problems in states such as Illinois and New Jersey. With 2,748 holdings this ETF is a comprehensive ETF. According to the fund’s sponsor BlackRock (NYSE: BLK ): The iShares National AMT-Free Muni ETF seeks to track the investment results of an index composed of investment-grade U.S. bonds. The index Blackrock is referring to is the S&P National AMT-Free Municipal Bond Index or {SPMUNUST}. Currently the index has 10,310 issues versus the 2,748 in the ETF, as mentioned above. U.S. territories, including Puerto Rico are excluded from the index. The index is rebalanced monthly and the fund is rebalanced on a monthly basis as well. With such a large quantity difference between the index and ETF the indexing strategy of “Representative sampling” is the most appropriate here. According to the prospectus, this involves simply investing in a representative sample of securities that collectively has an investment profile similar to that of the underlying index. According to S&P, the overall index is designed to track the larger more liquid bonds in the marketplace. Investment grade general obligation, (GO) and essential purpose revenue bonds are included, while high yield bonds are excluded. In terms of a breakdown of the credit quality of the ETF it is not as simple as our past analysis. In most of our previous analysis we would go over each and every issue in an ETF and break down the credit quality and weight the ratings for both S&P and Moody’s. Unfortunately, with over 2,700 issues we decided to defer to the sponsor. iShares by Blackrock uses ratings from S&P, Moody’s and Fitch and converts them to the equivalent S&P major rating category. MUB Credit Quality S&P Ratings&Equivalent Weight Cash and/or Derivatives 0.33% AAA Rated 21.47% AA Rated 56.86% A Rated 20.05% BBB Rated 1.29% According to Morningstar , they cite a .04% in BB rated debt as of June 30, while Fidelity cites .02% in high yield, as of July 20. We attribute these small figures in the below investment grade category to a few recent downgraded and split credit ratings. As such, we can categorically state that the underlying holdings are higher investment grade issues and as noted, almost 25% are AAA rated. Our first point of analysis was the sectors of the ETF. We needed to examine which sectors of the ETF represent exposure in the marketplace. We were expecting only a small divergence between informational sources. What we found was a little confusing. iShares breakdown is quite broad based, while Morningstar is narrower in scope. We elected to use Morningstar’s sector weightings. Sectors of MUB holdings Sector Weight State and Local General Obligation (GO) 31.81% Transportation 23.31% Education 13.39% Water & Sewer 10.68% Advance Refunded or Escrow 8.67% Utilities 5.32% Industrial 1.65% Health 0.06% Housing 0.05% While Morningstar’s breakdown seems thorough it is confusing when compared to iShares. iShares uses: State Tax-Backed: 39.49%, Utility (which makes sense in aggregate with water & sewer): 16.56%, Transportation: 14.82%, Local Tax-Backed: 10.91%, Pre-refunded/Escrow (almost in agreement):8.96%, School Districts: 5.26%, Education: 3.11% and Other Utilities: .52%. As such, in any event the sector risks here are limited to only industrial and health. The primary reasons are the GO’s are backed by the full faith and credit (i.e. taxes), while the “WET” (water, electricity and transportation) are backed by fees and are unlikely to be terminated at any cost. The not so recent Detroit Ch. 9 bankruptcy is a key example of this facet of “WET” issues. The municipality continued to provide these essential services after filing for Chapter 9. The advanced refunded or escrow bonds at 8.67% are AAA and backed by US treasuries (actually, what are termed “slugs”) and are not an issue whatsoever. In terms of the maturity breakdown there is a divergence again in information from iShares and other providers. In this case, we strictly use iShares information. The main reasons is that iShares uses a “Weighted Average Life” or WAL to determine their average length of time to repayment of principal for the securities in the ETF. They use this metric due to the fact that many, if not all, of the high coupon bonds in the ETF will be called. The other information providers do not consider it. MUB Maturity breakdown (WAL) Maturity Weight Cash and/or Derivatives 0.64 0-3 years 19.40 3-6 years 12.71 6-8 years 7.18 8-10 years 5.96 10-12 years 5.98 12-15 years 7.83 15-20 years 13.24 20-25 years 14.04 25+ years 13.03 Morningstar states the maturities using actual dates with a different scale as well. As such an actual comparison is difficult on almost all categories. For information here are Morningstar’s maturity breakdown: 1-3 years: 8.71%, 3-5 years: 8.69%, 5-7 years: 8.67%, 7-10 years: 10.84%, 10-15 years: 16.45%, 15-20 years: 16.21%, 20-30 years: 26.71%, and over 30 years: 3.71%. Fidelity’s maturity breakdown is far simpler: Short Term: 12.65%, Intermediate Term: 26.90%, and Long Term: 60.17%. We interpret the WAL structure from iShares as what is termed a “barbell approach” with heavy weighting on the short end, in terms of callable and pre-refunded issues and a good sized weighting on the long end to take advantage of the higher coupons in term bonds. A key determinant here is of course, not just maturity but duration. We will examine this shortly after reviewing the top 15 issues and their geographic locations. For information purposes here are the top 15 issues with description, coupon and maturity, ratings (Moody’s and S&P), duration, modified duration and yield to the worst and the underlying weight in the ETF: MUB top 15 holdings Unlike many other ETFs, (in terms of its top 15 weightings) the top 15 holdings represent only 3.986% and the balance of 2,736 holdings and negative (settlement) cash balance represents 96.034%. No holdings here represent even .50%, excluding the AAA rated muni money market fund sponsored by Blackrock. As such, we can categorically state this ETF is as close to a full spectrum of diverse issues. In terms of exposure in terms of maturity or duration, it is clear that if rates do go higher the value of the bonds will fall as their modified duration indicates a significant move from the current duration. In terms of a basic understanding, for those investors new to the concept of duration, from Investopedia: Modified duration is the approximate percentage change in a bond’s price for a 100 basis points change in yield, assuming that the bond’s expected cash flow does not change when the yield changes. As such, there is obviously exposure on the long end in this ETF, if and when rates rise. What this simply means is the bonds in the ETF will not be called if rates rise, the cash flow will stay the same and the value of the debt and underlying ETF will fall in price, accordingly. There is a way to determine weightings on a more in depth analytical level and this would be to examine the ETF on the state level. In terms of state geographic breakdown, the weightings are informative. Here are the top 15 states by weightings: MUB Geography top 15 States State Weight California 23.04% New York 19.17% Texas 9.27% Massachusetts 4.99% New Jersey 4.51% Illinois 3.97% Florida 3.42% Pennsylvania 3.24% Washington 3.24% Georgia 2.50% Maryland 2.38% Arizona 1.67% North Carolina 1.46% District of Columbia 1.24% Connecticut 1.19% Our top three geographic holdings of California, New York and Texas make up 51.48% of the ETF. We expected the high tax states of California and New York to be represented but am a little surprised at the 9.30% weighting of the low,(or zero income) tax state Texas. We expected a higher weighting from Massachusetts and New Jersey. Investors concerned about the fiscal condition of Puerto Rico and its credit exposure will have no issues with this ETF. There are no Puerto Rico issues in this ETF as U.S. territories are excluded from the underlying index. Fees, Performance and Recommendation With an inception date 09/07/2007, the fund has an established track record that has encouraged institutional ownership. Unlike other fund sponsors, we were actually able to obtain detailed information on the underlying index as well. Many readers have appreciated the table format, and we have decided to provide one for this section. The index ticker of the S&P National AMT-Free Municipal Bond Index is {SPMUNUST}. Category {MUB} {SPMUNUST} Net Expense Ratio .25% – Weighted Average Yield to Maturity 1.98% – Weighted Average Maturity 5.49 years 13.53 years 12-Month Yield 2.63% 2.98% SEC 30-Day Yield 1.81% NA Distribution Yield 2.63% 3.07% (YTM) Weighted Average Coupon 4.69% 4.61% Effective Duration/Modified Duration 4.71 years/NA N/A/4.69 years 12-Month Total Return 2.26% 2.98% YTD Total Return .23% .60% Shares Beta/Holdings Beta -0.11/NA NA Annual Portfolio Turnover 5.00% NA Reviewing each of the categories beginning with the Net Expense Ratio of .25%, shows little surprises. The asset class median is .30%. In terms of the yields, they are quite attractive with a reasonably short duration attributed to the call schedule of the issues in the ETF. This is in spite of a weighted average maturity of 13.53 years on the index. The ETF has almost 60% less in terms of the index weighted average due to calls and pre-refunded issues. This attribute lowers the weighted average significantly. In terms of returns the 12 month yield has been consistent and iShares states a tax equivalent distribution yield of 4.65% which is considered quite attractive for high rated municipal bonds. The Year to date return is quite low. This is attributed to the intermittent sell offs in the overall bond market and concerns about rising rates in fixed income markets. There have also been concerns about pension exposure in various states. A few states in the past, such as Kansas in 2014, were charged by the SEC for securities fraud regarding their pension liabilities. While Schwab has warned of possible defaults, downgrades are still possible but mostly in local municipal issues and cities, i.e. Chicago. The exposure to downgrades in the issues in this ETF would be light at best. In any event, with the holdings extremely broad based with state diversification we do not consider this a concern for this particular ETF. The share turnover of 5% is quite low compared with the asset class median of 25%, and the Beta of the shares indicates an extremely low risk investment as compared to equities and almost close to the beta of T-bills (0). The ETF has been and continues to be a stable “cash cow” vehicle for many funds with an increase of 12.83% in the current quarter alone. Some of the largest institutional owners include PNC Financial Services (NYSE: PNC ) (with 7.37% ownership), Bank of America (NYSE: BAC ), UBS Group AG (NYSE: UBS ), and Morgan Stanley (NYSE: MS ). Though, mutual funds have been net sellers for the past few quarters we attribute this to investor concerns over rising rates and further changes to asset allocation models. In any event, overall net flows for the month of June indicate an increase of $108.46M. With a 52-week high of $112.20 and a 52-week low of $107.58, the shares closed at $109.07 -.10 on July 28. Our Recommendation With a very low price range and low beta we do like this ETF as a very low cost way to invest in Municipals in the ETF space during a possible rising rate environment. As many advisors and institutions have decided, this leader of the muni ETFs is an excellent place to invest funds for both the short and long term. As we stated in our analysis on other ETFs, we feel this ETF will continue to provide an attractive yield in a stable-to-slowly rising rate environment. We do expect slight price erosion in a rising rate environment but far less than other municipal funds and ETFs in the marketplace. We do not expect a decrease in yields in this ETF, bearing a large scale default and lower yields going forward. Overall, it is an attractive investment for stable yield-hungry institutions and individual investors alike. 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. Additional disclosure: Information obtained from: ishares.com, morningstar.com, us.spindices.com,fidelity,com, yahoofinance.com, standardandpoors.com, moodys.com, wolfstreet.com,xtf.com, and our own analysis