IM rants

This was just way too funny to not post.

The article in reference is from Bloomberg and you can read it for yourself right HERE

Neapolitan Man: that article, was like parents telling their teenager they are going out of town for a week and not to throw a party

LH: LOL

Neapolitan Man: it was so absurd

LH: yea, and that the key to the liquor cabinet is hid under the sink

LH: ...

Neapolitan Man: yea

Neapolitan Man: as they are pulling away the kegs and nitrous tanks are pulling up

LH: hahaha

LH: wait, what? who brings the nitrous

LH: {but it sounds awesome}

Neapolitan Man: the bankers do

Neapolitan Man: this isn't your normal kegger

Neapolitan Man: they are going to rape and pillage with 200 billion every month

LH: yea

LH: but

LH: for how long

LH: and can we assume that when they turn off the spigot

LH: the world reverts?

Neapolitan Man: i don't know, if it is up to lloyd it will go on for at least a year maybe 2

LH: damn

Neapolitan Man: the world will never be the same

On a side note. We're convinced that the one of the better plays for the next few weeks is....wait for it.....

LONG GAMMA 

By purchasing equity gamma or yield curve gamma you get the exposure to the following upcoming events:

1. First Look GDP {10/29}

2. Nov Elections {11/2}

3. Fed Meeting {11/2 - 11/3}

4. October Unemployment data {11/5}

5. Treasury Auctions {11/8 - 11/10}

6. QE2??????

~LH

Conversation with a King

Remember when I introduced you to the 3 Kings? They were the three champions of the bond option pit whose trading savvy and skill produced millions of dollars in profits all while taking down paper from the masters of universe {read PIMCO & Goldman Sachs}. Most of these guys have moved on to 'greener pastures' and left the pit-life to the younger kids. But traders are creatures of habit and the longer you're in the game, the harder it is to turn off the constant internal dialog that was the key .

Knowing he couldn't turn off the dialog led me to ask about our current NOB dilemma. We've struggled for the past few days to construct a trade that limits our exposure while allowing us to capture what price action we anticipate in the coming weeks. Knowing that the kings had insight and perhaps the most valuable key: trading experience, I decided to seek out that wisdom.

Interestingly, it started with a question. He asked why we thought the NOB was going to make a retracement from its new 24 year high (149 bps)? I laid out our argument and theory.

• Paper is LONG the short end of the curve and getting longer. It has been the trade of least resistance and all pushed 2 year and 5 year yields to record lows. {Our office has discussed the real possibility of the 5 year yield going to 1% for the last 3 months...its almost there}
• There aren't necessarily 'sellers' in the long end {and ultra long} rather there is just a lack of buyers with respect to the huge amount of dollars being poured into the short end.
• We believe that a prevailing opinion is that: its better to be long these securities and in the worst case scenario they will to take delivery.
• The 5-7 year future {7-10 US Notes} hold the real possibly of recovery. 
• The biggest players have started to put on yield flatterns via the option complex.

He laid out his view of the playing field. Though similar, he saw the crux point from a different angle.

• The trade has been for paper {PIMCO} to hedge all of the mortgages they've bought over the last 2 years.
• Paper sees the government as the backstop of all these mortgages and {spoiler, this has a touch of conspiracy theory to it, PrD would be proud}since there was no way for the government to actually buy all the rotting paper out there they cut PIMCO in on a very sweet deal and virtually guaranteed their principle investment.
• Paper isn't viewing the 5-7 year trade. Rather they are staking out the QE2 announcement for the correction of the current trend.
• He suggested looking back 3-4 months and see what happened as the NOB self correct from 125 down to 110.
• He envisioned a 'non announcement' on November 2nd's Fed Meeting will result in a massive sell off in the 2-7 year notes.

The question we are forced to answer is: Are we on the mountain top getting ready to ski down the double black diamond or are we at the halfway point and preparing for the assault up 29,000 feet?

Realistically, are we traders that follow the trend or look for the mean reversion? I'd argue that we're the latter. Now to craft a play.

~LH

Executing for the Why

I am enjoying my front row seat the the show this morning.

In the blue trunks, standing slightly shorter now, is Interest Rate Volatility. In the red trunks, growing more powerful by the second, is the 4 ton gorilla named market angst. I've got to be honest, with all the movement recently {albeit in one direction}, the impending QE2 scenarios, Bernanke's 3 point attack as outlined at Jackson Hole, and the every pundit in the world calling for a Bond Bubble {and subsequently a massive sell-off}I thought that IRV would put up a little better fight.

NOPE!

The pummeling is merciless and I'm starting to get squeamish watching this. One of our market brokers said, "This is the lowest I've ever seen Mid-Curve EuroDollar straddles {vol} in all of my years down here." That must be bad.

Interestingly enough, we're long this rapidly rotting volatility. The other day we purchased E0X92 straddles vs 9929 for an average price of 16.5. Our current hedging has left us short deltas from an average of 9934.5 at roughly 60% hedge ratio. However, our next sale isn't until 9947 and at least prior to the NFP number, our first buy is around 9921. Good luck Mr. Gamma.

~LH

Mentally taxing

There aren't many days that will rival May 6th. It's interesting how a 1000 point swing in the Dow will make everyone forget the April Unemployment report that came out May 7th.

As an option trader, I found a sick pleasure is watching the violent swings across every asset class. Whether it was the bonds gap higher or the S&P's crushing decent, I was fascinated at the power of their respective retracements.

My hope is that the locals in my former pits were all long gamma and had a chance to really stick it to paper! Though, history tells me that that is rarely the case. Paper has an uncanny ability to strip the pit of all gamma {and vega} prior to moves like May 6th. As usual, we were always the last to know.

Sitting on the desk, just a few moments before the wheels came off the wagon I witnessed an interesting phenomenon in the Fed Funds markets. Many of the back months futures (Jan 2011 and later) are priced by one or two very large firms and their algo-trading model. Usually these computers keep the markets a few ticks wide and though they're rarely afforded the opportunity trade these contracts, they will snap into action if something seems out of line. However, just a few moments before the massive selling in the S&P's the machines widened their markets. 30 seconds later, they actually pulled themselves out of the market entirely. When that happened, every other computer driven model was clueless and they pulled their markets as well, in EVERY Fed Funds market {even spreads}. As I looked around the room at the other various traders we came to the sudden realization that we were the only people dumb enough to still be making markets. As we scrambled to hit our 'PULL ALL' buttons, the chaos began.

Hindsight trading is 20/20 and everyone would be a millionaire. I was personally disappointed in my inability to buy some of the insanely cheap spreads in our markets. This past weekend, I was reminded by one of my old friends who says it best, 

"What beat me was not having brains enough to stick to my own game--that is to play the market only when I was satisfied that precedents favored my play." Reminiscences of a Stock Operator Lefevre.

It was favorable to buy everything at almost zero and then watch them all trade up 2 full ticks. If there's a next time, I pray I'll be able to pull the trigger.

~LH