Tag Archives: fn-end

Investors Are Scared – Getting Long Volatility Again

Last week I offered up a playbook for volatility for this year. Since that time I’ve shorted volatility and subsequently gotten long. I’ll continue to use a hedged position selling calls against the VXX until the volatility outlook changes. Last week I wrote a piece regarding volatility in the new year and my playbook for how to survive the strong moves up and down in volatility as measure by the short term VIX ETF (NYSEARCA: VXX ). At the time I had no positions as I was waiting for a more definitive move up or down in order to stake my claim on the VXX. I wrote I wanted to see a bigger move up before shorting and since the time the article was published, VXX has moved sharply to the upside to trade near $35 as I write this. So what have I done since the last article and what am I doing going forward? After being out of the VXX for a couple of weeks I actually decided to get short volatility after another move up following my article. I used the inverse short term VIX (NASDAQ: XIV ) ETF to do so to try and capture a move down in the VXX. I went long XIV on the 7th and captured a very nice move down in volatility only to have it reversed on Monday the 12th. After seeing the move down in volatility was short lived I closed my XIV position for a very small gain (after riding the XIV up and back down) and went long VXX again. Why did I go long? There is a lot of stuff going on in the financial world. Oil and other commodities continue to signal that a recession is coming, Greece is once again on the verge of breaking up the Euro and here at home, the market hangs on the Fed’s every word in terms of any potential volatility that could be introduced from the central bank raising rates and pulling stimulus. These factors make me think the likely move in volatility is up in the short term, not down. I’m currently long VXX while selling calls against my position. I did this for two reasons. First, in case I’m wrong, VXX can move down in a hurry and crush you. This is the same problem the short volatility ETFs have and that’s why I trade in and out so much and why you’ve got to be careful. The calls give me some cushion on the downside in exchange for taking away my upside in case volatility collapses. Second, I sold the calls simply because premiums are huge. Slightly out of the money calls can be sold for 5% of the ETFs price – for an option that expires in a week. Think about that one; that kind of yield for five or six trading days is unbelievable and it provides not only huge amounts of cash for your portfolio but a nice bit of protection to the downside. I went long VXX at $33.30 and sold weekly 33 calls against my position for $1.46, expiring four days after I sold them. Given the move up in the VXX to $34.40, I’ve given some upside away but I’m still collecting the huge premium in the meantime, offering 3.5% yield and some downside protection as I sold in the money calls. Given the outlook for continued volatility I think the best course of action going forward is hedged bets in the VXX. Last October and again in December of last year I went long the inverse VXX ETF (NYSEARCA: SVXY ) or the VXX itself with no protection as the situation warranted because I felt strongly I could predict what volatility was doing. But given all of the places we can expect news from in the short term, I don’t feel confident enough to just buy VXX or XIV. I like the covered call play on VXX right now but if VXX spikes to the high $30s, as I said in my last article, I’ll look at doing the same think with XIV. But for now, I’m long VXX until something changes and when it does, I’ll be sure to let you know. Additional disclosure: I’m long VXX hedged with short calls but may trade out of this position at any time.

Watch Your Step When Using Bond Ladder ETFs

By Thomas Boccellari Institutional investors, such as insurance companies and pension plans, have long used their bond portfolios to match their interest and principal repayments with their cash flow needs. One way to accomplish this is to construct a portfolio of bonds with different maturity dates that correspond with the investor’s obligations. This is known as a bond ladder, and it can help mitigate interest-rate and liquidity risk. However, building a bond ladder can be expensive and time-consuming. Because bonds are traded over the counter, bid-ask spreads may be wide. Additionally, brokerage firms can charge high commissions for bond trades. Bond ladder exchange-traded funds can help solve some of these problems. Because bond ladder ETFs, such as Guggenheim Investment’s BulletShares and iShare’s iBonds, hold bonds from upwards of 100 different issuers, credit risk is more evenly spread around a portfolio. Further, because they don’t have lofty purchase minimums, like many bonds available through a broker, investors can get exposure to a variety of different bonds with very little capital. Strategies for Using Bond Ladder ETFs Within a Portfolio Suppose an investor knows that she will need to pay for a wedding and a down payment on a new home in one and three years, respectively. The investor may wish to set aside a certain amount of capital to pay for those future obligations. In the meantime, however, the investor would like to collect interest on her capital. If the investor buys a traditional bond mutual fund or ETF, she runs the risk of not getting back her original investment because of potential interest-rate movements that could push bond prices lower. To mitigate this risk, she could buy iShares iBonds September 2016 AMT-Free Municipal Bond (NYSEARCA: IBME ) and iShares iBonds September 2018 AMT-Free Municipal Bond (NYSEARCA: IBMG ) to match her portfolio’s maturity dates with her corresponding spending needs. This would allow her to collect income while getting her full investment principal back to pay for her obligations. Laddered bond ETFs also give investors better control over their portfolio duration, or interest-rate sensitivity. For example, suppose an investor wants exposure to investment-grade corporate bonds but is afraid that a traditional corporate-bond ETF, such as SPDR Barclays Intermediate Term Corporate Bond ETF (NYSEARCA: ITR ) , has too much exposure to bonds maturing between five and 10 years from now and is too exposed to interest-rate movements. To mitigate this risk, she could use Guggenheim BulletShares 2015/2016/2017/2018 Corporate Bond ETF (NYSEARCA: BSCF ) / (NYSEARCA: BSCG ) / (NYSEARCA: BSCH ) / (NYSEARCA: BSCI ) to give an overweighting to bonds with maturities of less than five years from now and reduce her portfolio’s overall exposure to interest-rate risk. Bond Ladder ETF structure Like an individual bond, a bond ladder ETF has a predefined maturity date. The fund can do this because it only buys bonds maturating in the year the ETF terminates. For example, Guggenheim BulletShares 2015 Corporate Bond ETF ( BSCF ) tracks an index that targets investment-grade corporate bonds maturing in 2015. The fund terminates (matures) on Dec. 31, 2015. At maturity, the fund’s assets are returned to investors. Because the fund has a predefined maturity date, it will behave differently from traditional bond ETFs. A traditional bond ETF targets a consistent range of bonds. For example, ITR targets U.S. dollar-denominated bonds with maturities between one and 10 years. During the fund’s monthly rebalancing, it will buy new bond issuances that have maturities between one and 10 years and sell bonds that no longer meet the maturity requirement. This keeps the fund’s duration relatively consistent. On the other hand, a laddered bond ETF only replaces bonds that are called. Otherwise, it holds securities until maturity or the fund’s termination date, which is usually in the same year that all of its bonds mature. This means that the laddered bond ETF’s duration will decline as the fund approaches maturity. While one would expect a laddered bond ETF to make consistent interest payments throughout its life, like an individual bond, this has not been the case. In fact, for funds within the BulletShares and iBonds families, monthly distributions have decreased at a similar rate to that of a traditional bond fund over the trailing five years through December 2014. Laddered bond ETFs’ inclusion of callable bonds could help explain this. Issuers can buy (call) back callable bonds if their price exceeds a predetermined level, which typically occurs when interest rates fall. The fund then has to replace these bonds with lower-yielding alternatives. Callable bonds are not the only problem. Companies have also refinanced their debt because of prolonged low interest rates. This has the same effect as when a bond is called. Further, if a bond matures, is called, or is redeemed after the final rebalancing, the bond is not reinvested in a corporate bond. It is instead kept in Treasury bills until the fund terminates. For Guggenheim BulletShares, the final rebalancing date is July 1 of the termination year. Therefore, if a bond matures, is called, or is redeemed after July 1 of the fund’s termination year, investors will lose more interest and not have the ability to reinvest their principal. This also means that investors won’t get back exactly their original principal plus interest because not all bonds are held until the fund’s maturity. At the start of 2014, BSCF had 285 bonds. By the end of 2014, 23 bonds dropped out because they were called or redeemed early. This had an impact on the fund’s distribution amount. Over the life of the fund, it saw its distribution percentage decline in a similar fashion to that of ITR. The difference in distribution percentage between BSCF and ITR is roughly equivalent to the difference in the funds’ expense ratios. Distributions are higher in December of each year because both funds include both the December and January distributions in December. Lastly, investors need to be aware of the additional costs associated with buying additional funds. If an investor decides to build a five-bond ladder, there will be at least five transactions. These costs can also increase if investors decide to roll their terminated ETFs’ assets into new funds. For investors who are comfortable with the structural risks of these funds, they are a cheaper, easier to build, and safer alternative to individual bond ladders. But traditional bond ETFs may be a better choice for investors looking for aggregate exposure to a particular type of bond or maturity range. Disclosure: Morningstar, Inc. licenses its indexes to institutions for a variety of reasons, including the creation of investment products and the benchmarking of existing products. When licensing indexes for the creation or benchmarking of investment products, Morningstar receives fees that are mainly based on fund assets under management. As of Sept. 30, 2012, AlphaPro Management, BlackRock Asset Management, First Asset, First Trust, Invesco, Merrill Lynch, Northern Trust, Nuveen, and Van Eck license one or more Morningstar indexes for this purpose. These investment products are not sponsored, issued, marketed, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in any investment product based on or benchmarked against a Morningstar index.

Falling U.S. Inflation Could Drive Up SLV

The price of SLV rallied by 5% during the year, up to date. Falling U.S. inflation may pull up SLV via the drop in U.S. treasury yields. The recent Non-farm payroll was inline with market expectations, but it didn’t drag down SLV. After losing nearly 8% during the last quarter of 2014, the iShares Silver Trust ETF (NYSEARCA: SLV ) showed some signs of recovery as its price added over 5% during this month. Even the strong results from the last non-farm payroll report didn’t curb down the price of SLV from picking up. Let’s review the relation among the developments in the U.S. labor market, inflation and the progress of SLV. The non-farm payroll report was published on Friday. It showed a 252 thousand of jobs added during December. Moreover, the previous two months were revised up by 50 thousand jobs. The rate of unemployment slipped to 5.6%. The table below shows the changes in SLV and the non-farm payroll results in 2014. Source of data taken from Bureau of Labor Statistics As you can see, the correlation between the changes in the gap between market projections and actual figures and the price of SLV is mid-strong and negative at -0.45 – this result suggests that as long as the number of jobs added doesn’t exceed market expectations, the price of SLV is likely to rally. Despite the recent rise of SLV last week, the ongoing recovery of the U.S. labor market doesn’t play in favor of SLV. This recovery, however, still has a long way to go until the U.S. labor market shows a full recovery – mainly in wages. Based on the recent report, hourly wages grew by only 1.7% on an annual pace. This is still a low level and remains well below the levels recorded before the 2008 economic meltdown. The other major report related to the U.S. labor market is the upcoming JOLTS report, which will be published this week. (click to enlarge) Source of data taken from Bureau of Labor Statistics Albeit the price of SLV doesn’t have as strong relation to the JOLTS figures as it does with the non-farm payroll. This is still an important report that could indicate the progress of the U.S. economy. The current estimates are for the report to show a 4.91 million jobs opening. The upcoming U.S. CPI and PPI, which will be released this week, could provide another measurement about the changes of the U.S. inflation. If the U.S. core inflation continues to slowly come down, this doesn’t vote well for rise in U.S. wages. The fall in U.S. inflation, however, could actually play in favor of SLV. At the very least, it may play this year in two roles when it comes to SLV. Usually, lower inflation tends to steer away investors, who fear of a potential spike in inflation, from precious metals investments such as SLV. The chart below presents the relation between core CPI and SLV during 2013-2014. Source of data taken from Bureau of Labor Statistics and Google finance Most of the drop in U.S. inflation was stemmed, as you well know, from falling oil prices. During the past few months, the correlation between SLV and oil prices was mid-strong and positive at 0.4. Albeit the price of SLV remained relatively flat, oil prices tumbled down by more than 40% in the past three months. So why falling oil prices could actually be good for SLV? As U.S. inflation falls, this is likely to reduce the odds of the FOMC raising rates. For now, the market still expects the FOMC to raise rates by the middle of the year. Alas, if U.S. inflation does tumble down, it could eventually influence FOMC members to reevaluate their policy. Finally, falling U.S. inflation is also likely to keep down U.S. long term treasuries yields, which tend to have a negative relation with the price of SLV. Therefore, falling long term treasuries yields driven, in part, by lower inflation provide the environment needed to keep pulling up SLV. For more see: Choosing Between Gold and Silver