Tag Archives: macro-view

Trading Volatility: The Hunt For Disaster Is The New Gold Rush

Summary Lessons from the original Gold Rush. Trading volatility on the long side is rarely profitable. Time, math and yourself are your enemies when you are long volatility. The Original Gold Rush On January 24th, 1848, James Marshall, a carpenter out of New Jersey, found gold flakes in the American River at the base of the Sierra Nevada mountains in California at a sawmill owned by John Sutter. Word spread of the gold finding and storekeeper Sam Brannan set off a frenzy when he paraded through San Francisco with a vial of gold obtained from Sutter’s Creek. At the time, the population of California was 6,500 Mexicans and 700 Americans (not counting Native Americans). By mid-June, 75% of the male population of San Francisco left town for the gold mines and the number of miners reached 4,000 by August of 1848. Throughout 1849, people around the United States (mostly men) borrowed money, mortgaged their property or spent their life savings to make the arduous journey to California. By the end of 1849, the non-native population of California ballooned to 100,000 with San Francisco establishing itself as the central metropolis of the new frontier. This invasion of the 49ers promptly lead to California’s admission to the Union as the 31st state. By 1850 (1 year later) surface gold in California largely disappeared even as miners continued to arrive. Mining is a difficult and dangerous labor and striking it rich requires good luck as much as skill and hard work. You have to be able to canvas a large territory, pick at various locations and if they don’t produce, abandon them immediately for the next opportunity. While most gold miners didn’t succeed in getting rich from gold mining, California’s economy got off the ground and the by end of the 1850’s California’s population was north of 380,000 with a bustling economy. The Hunt For Disaster Is The New Gold Rush Trading volatility on the long end is very much like gold mining. The opportunities are very few and far in between, but when they come, they can make you money quick. The ProShares Ultra VIX Short-Term Futures ETF ( UVXY) has had the following streaks since its inception in October of 2011 (these streaks are on closing basis): As you can see, if you took the same amount and invested it with just the perfect timing and got in at the bottom and got out at the top, you would have made 800%+ in about 280 days. On average about 50% return for each winning streak which lasts about 19 days. 50% return in 3 weeks? I would take that anytime. There have been 15 winning streaks since October of 2011 or about 1 streak per quarter. But therein lies the promise and curse of the Long Volatility Trade. While the returns can be spectacular while volatility is rising, it takes a lot of waiting for the moment to come when you can strike. Only 20% of the time does UVXY rise. Only every 3 weeks out of 3 months do we get an opportunity to make a good UVXY trade. 80% of the time UVXY goes down and it plunges head first. Since its inception, the fund is down 99.99% . If you bought and held UVXY since inception and you invested $1,000,000, you right now have about a $1. That’s right, $1 for your efforts! I mean if you are going to do that, go to Vegas and at least get some free drinks. The Psychology of Being Long Volatility In 2014, after having made some good money on being short volatility in 2012 and 2013, I decided to take a portion of the winnings in the VelocityShares Daily Inverse VIX Short-Term ETN ( XIV) and go on a psychedelic world tour through the dark side. I knew full well the statistical percentages and the pain I am about to experience, but like playing with fire, you don’t really know your physiological limitations until you experience it firsthand. I wanted to experience trading pain and ultimate ecstasy via the UVXY. The neural points that are triggered during a winning trading experience release higher quantities of serotonin (happy neurotransmitter) and as such explain the addiction to hopeless trading. So I decided to be very disciplined and have a rock solid stop-loss discipline, as I knew I’ll be on the bad side of the trade most of the time so I have to cut my losses short quickly. In the beginning I did exactly that. Starting in April of 2014, I made about 10 trades, in and out, 5% stop. But the losses started to add up. May 2014 didn’t provide a drawdown. 10 trades with 5% loss, by June I had only half the capital. Still knowing that I can hit 100% pretty quickly and recover my losses, I stayed in. June, July, August. Waiting and waiting for the right moment. Finally September came and provided the draw I was looking for. But at that point, I had been burned so many times over the past 4 months, I was now more wary and judicious. The first draw came and I missed it. I then waited for a quick rip and went long UVXY again. Another move down, boom. Made 50% on the trade. But then when we nearly hit the 10% drawdown, I decided to double down. If this had gone 10% down, it’s surely heading to 20% and that is when the big money in UVXY happens. The panic after the panic. And very briefly the futures completely collapsed over night on October 15th below every technical support. I am on my way to big money. Finally! But by the morning a sharp reversal came overnight, magically the futures went from 30 down to positive by the open, the HFT algos then took it and pushed it higher. I stayed in thinking that this was just a 1-2 day bounce. But not only was it not a bounce, it was a heart stopping rip. In 3 days, it rallied 80 points. The double on the UVXY position was down 50% just like that and the original profit was now completely gone. I stayed a couple of more days hoping for another dip to bail on better terms, but a dip was not to be. V shaped snap back usually found near bear market bottoms just happened at the top of a bull market 5 years strong. It was a major shorts carnage. Never happened before, but it happened now. That was the final nail on my UVXY adventure. With pretty much 85% of the capital lost, with my stop-loss discipline in tatters by the methodical pounding of UVXY’s relentless losses, betrayed by the worthless hope of high percentage returns, I quit the experiment. It’s ok to experience pain here and there, but this is simply well-refined torture. The medieval inquisition would be proud. Disaster may be fascinating, but it is a waste of time So while it is very tempting to trade disaster, disaster in fact happens only rarely and the losses far outweigh the gains. We are all drawn to disaster. There is nothing more exciting that to watch a well-designed and complex system fall apart. As an engineer or an analyst, you can love nothing more. You get to see how all the pieces interact, how these interactions malfunction, how the different pieces themselves malfunction. It’s like performing a surgery. It’s very educational. But we need not intermingle our fascination with disaster with our trading. It is a very expensive proposition. If you want to avoid disaster, go to cash, gold, something stable and ride out the moment. Trading it for profit is fool’s gold. The iPath S&P 500 VIX Short-Term Futures ETN ( VXX) and UVXY – do not touch with a 10-foot pole. Forget they even exist. Just go back to the world prior to 2009, when they didn’t exist. If I was the NASDAQ, I would require Option Level 2 approval before letting people trade those two instruments. Just stay out. Disclosure: I am/we are long XIV. (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.

India Small-Cap ETFs: Best Of Emerging Markets Now?

After witnessing two months of lull, the Indian stock market finally belied cynics in July as it easily combated global issues like the bursting of the Chinese stock market bubble, nagging Greek debt deal negotiations, looming Fed rate hike and the strength in the greenback. Investors also rushed to capitalize on this grit and poured Rs. 5,300 crore (net) in Indian equities last month. Reduced worries over monsoon deficiency, a timely correction in the stock market and rising domestic investment led the key Indian bourse to bounce back from late June. Earlier, investors were unnerved by apprehensions of lower rains this monsoon which would take a toll on the all-important agricultural sector and push up inflation. The fear was not baseless either as RBI cut India’s growth forecast for fiscal 2015-16 from 7.8% to 7.6%. However, contrary to this apprehension, rain deficiency has not been as severe as predicted. The Indian market surged over 30% last year. While most of the gains were wiped out this year on Fed rate hike concerns and a spate of downbeat economic indicators including weak corporate earnings and political gridlock causing hindrance in intended reforms, the correction opened the door to further expansion. This was truer given the extremely muted levels of energy and gold prices. This was because India imports more than 75% of its oil requirements and accounts for about 25% of the global gold demand. This makes the country highly susceptible to these commodities’ prices. India’s foreign-exchange reserves are close to a staggering $355 billion, which gives the economy the power to fight the expected volatility post Fed tightening, per Bloomberg . Unlike taper tantrums in 2013, Indian rupee remains largely stable and shed only 0.6% in the last one month (as of August 5, 2015) relative to the U.S. dollar. In fact, the uproar in global markets, mainly in Greece and China, brightened India’s appeal as a safer bet in the high-risk emerging market (EM) pack. The economy expanded 7.3% in 2014-15 versus 6.9% in 2013-14, indicating that the Indian economy is taking root. Of course, it has its set of issues like political gridlock, inflation woes, and a still-muted investment backdrop, but the economy appears much more stable than other emerging markets. A Look at Other Emerging Giants At this point of time, India scores higher than its other EM cousins like China, Brazil, Russia and South Africa. Chinese stocks are now infamous for extreme volatility having experienced recurrent market crashes since June. The country’s economy has also been displaying offhand economic data for long, leaving expectations for further monetary easing as the only hope in the China Investing theme. Popular Chinese equity ETF FXI was 7.8% down in the last one month. Coming to Brazil , the condition is more worrisome. As much as a 7.4% fall in the Brazilian real in the last one month (as of August 5, 2015) against the U.S. dollar, a commodity market slump, spiraling inflation and raise in rates (presently as high as 14.25% , almost double that of India’s) have crippled the Brazilian economy. Analysts have raised the 2015 inflation outlook for Brazil from 9.23% to 9.25% while its GDP is expected to shrink by 1.8% from the prior forecast of 1.76% contraction. The largest Brazilian ETF EWZ was down about 13% in the last one month. Russia is yet another emerging market which turned a bear from once-a-bull country. An unbelievably prolonged and steep fall in oil prices, Western bans and an 11.7% one-month slide in the Russian currency clearly explain the pains for this oil-rich nation. The IMF now expects the Russian economy to skid into ” deep recession ” (down 3.4%) in 2015. The most popular Russian ETF RSX lost 4.7% in the last one month. The Indonesian currency was almost resilient to dollar gains but weak corporate earnings and a spate of soft economic data weighed heavily on investors’ sentiments. Dollar gained just 1.2% in the last one month against Indonesian Rupiah. The World Bank also slashed its projection for Indonesia’s 2015 economic growth from 5.2% to 4.7%. Indonesia ETF EIDO was off 3% in the last one month. South Africa’s currency shed about 3.3% in strength in the last one month (as of August 5, 2015) and growth prospects remain bleak. This is also a commodity-rich nation and will likely the bear the brunt of the commodity market crash. South African ETF EZA retreated 2.2% in the last one month. Turkish lira also slipped 3.3% last month (as of August 5, 2015). Along with this, political upheaval and still-subdued growth in the EM pack led the Turkey ETF TUR to shed about 9% in the past 30 days. Reasons to Cheer for Indian Small Caps Since small caps better reflect an economy’s strength and are largely unruffled by global shocks, Indian small caps should be the best-positioned EM options right now. Investors are advised to take a peek into our top-ranked ETFs, India Small Cap ETF (NYSEARCA: SCIN ), India Small-Cap Index ETF (NYSEARCA: SCIF ) and iShares MSCI India Small Cap Index Fund (BATS: SMIN ). Each carries a Zacks ETF Rank #2 (Buy). SCIN, SCIF and SMIN added 9.2%, 9.7% and 6.8%, respectively, in the last one-month period while in the past one-week frame, the trio advanced 5.5%, 4.7% and 4.8% (as of August 5, 2015). Original Post

The 3 Key Elements Of A Bond ETF

As the Head of Fixed Income Strategy for iShares, I am fully versed in the seemingly complex world of bond ETFs. I wanted to take a little time to explore the basics for you, because the only way to fully appreciate the benefits that this type of investment can offer is to first understand how they work. First things first – here are three key elements that every investor should know: 1. A bond ETF typically tracks an index. While there are a few actively-managed fixed income ETFs, for our purposes we’ll focus on index-based products, which generally seek to track the performance of an index minus fees and expenses, and make up the majority of bond ETFs out there. Like equity indexes, bond indexes typically target a specific part of the market – such as a specific sector (e.g. Treasuries, corporates), credit rating (e.g. Aaa-A), or maturity range (e.g. 7-10 years). Bond indexes combine these elements in a variety of ways, allowing investors to access both broad and narrow segments of the bond market through the ETFs that track them. For example, you can access the total investment grade bond market through a fund like the iShares Core Total US Bond Market ETF (NYSEARCA: AGG ), or specifically target U.S. corporate bonds through a fund like the iShares Aaa-A Rated Corporate Bond ETF (NYSEARCA: QLTA ). Bottom line: Understanding the underlying index is key to knowing what you own in a bond ETF. 2. A bond ETF’s current price is visible and updated throughout the day on an exchange. While some investors appreciate the fact that they can trade an ETF intraday, others may never take advantage of this feature. And that’s okay, because the mere fact that bond ETFs trade on the stock exchange is still a benefit for those investors, because it provides price transparency in an otherwise opaque market. Individual bonds trade over-the-counter (OTC), which means that buyers and sellers negotiate individually in order to reach a deal. As a result, bonds can be hard to track down and quotes from different brokers can vary widely. In contrast, investors can see bond ETF execution prices on an exchange throughout the trading day. You can see what price at which you can buy and sell the ETF, allowing you to make more informed decisions about your bond investments. This can be particularly powerful during periods of time when markets are moving quickly or segments of the bond market are experiencing illiquidity. Bottom line: Whether you intend to trade or not, the fact that bond ETFs offer transparent pricing arms you with valuable information that can help you make an informed investment decision. 3. A bond ETF is managed by a human (sometimes several). A common misconception about bond ETFs is that they simply hold all the securities in the index they track, rendering a portfolio manager (PM) unnecessary. This is actually a flattering assumption; because if a bond ETF manager or PM is doing the job correctly investors are simply getting the exposure they expect, without much deviation from the performance of the underlying index (otherwise known as tracking error). The actions of the bond ETF manager are invisible. The truth is that there is a lot of work going on behind the scenes to make this happen. Bond indexes can hold hundreds and sometimes thousands of bonds, some of which are illiquid or thinly traded. As a result, a bond ETF manager is required to construct a portfolio that tracks the index as closely as possible using only the securities that are available at any given time. This can be particularly tricky in certain situations (for example, an illiquid market segment like high yield), but a good PM is able to navigate a range of market environments. Bottom line: Bond ETFs do have portfolio managers, and a skilled one will work to minimize tracking error on an ongoing basis so that investors get the exposure they’re seeking. Of course, there’s much more to the story than this, but these three points really get to the heart of what a bond ETF is. Original Post