A pair of conspiracy theories

I don't want to delve into conspiracy theories as though they are the gospel. I don't really care if you believe the moon landing was faked or if there was a second gunman in JFK's assassination. But when all the stars line up and the coincidences start piling on top of each other there has to be something else out there, right? 

The first of these theories hit my email via the Old Baron in the office. He found an article on Seeking Alpha that  resonated with him. He's an old pit trader that made his first career as broker in the 30 year bond future's pit. He's seen countless auctions, witness innumerable bid to cover ratios, and experienced his fair share of governmental failures, but he notes that this last round of debt is different.

Graham Summers beautifully articulates that Something Very Strange is Happening With Treasuries, and walks the reader through what seems to be a very plausible explanation for the latest round of auctions. It's a short read, but for anyone with a conspiracy theory mindset, the message loud and alarming. He proposes that the government is covertly buying its own securities through indirect bidders (bids placed through direct bidders that CANNOT be tracked or traced) to make up for the slack left by forgein governments disinterest in our debt. If true (and I admit, on the surface he proposes a very conceivable argument), then the yields are due to move higher as bond vigilantes begin to demand a better return on their dollar. Messaging being, it might be time to get short the Ten Year Future and sit back to watch the fireworks.

The second of these theories is concocted from years of floor experience and our trading desk's collective memories of past trades with Stan Jonas. It's hard to find much of anything on this minor Wall Street legend. Googling his name gets you a few blips here and there, a transcript from the PBS Nova show discussing the effects of LTCM and a couple randomly tagged articles that lead to virtually nothing. But ask the guys who trade on the floor who Jonas is and you'll hear more trading stories than you care to listen to. You'll hear from pit brokers how he demanded lower rates. You'll hear from locals about the times he structured an exotic 8-legged option spread that had the smallest window of incredible returns and nailed it to the tick. And you'll hear from desk brokers that his calls are almost too perfect to coincidental.

Flash back to mid-September. The FFG10 was trading around 9955 and locals were still pricing in about a 50% of a rate hike by early 2010 (oops...) It was at this point that the Jonas playbook was opened. He sold the ATM puts in February to buy a 37.5 tick wide up-side call spread. The prices (based on the underlying future) were such that the premium in the trade was actually to the put meaning that he collected ticks to initiate this trade. Subsequently, the locals rushed to buy futures to cover their risk, sending the underlying soaring higher and right into his long call spread. Not only did get paid to be sythetically long February futures, he got the locals to drive the price up to make the call spread part of his trade in-the-money. Now it's true that I have no idea if he was hedging a ED position or if he already had some type of Fed Funds postion risk that he was managing. If he didn't, that traded netted him around 23mm (assuming he let it expire as Feb rolled off the board). Not bad, and the people who suffered? Just the locals as they are almost the last to know.

It's this knowledge that this latest conspiracy is sparked from. On Friday, Jonas opened his play book again and this time it was the November Fed Fund Future that he made his muse. He sold 1000 9956.25/9962.5 put stupids and collected a whopping 22,000 ticks in the process (roughly $915,000). The market had been (and still is) pricing in about a 45% chance of a 25 bps rate hike by then. However, this trade exposes him to 2000 longs that would incredibly costly if the Fed raises the rate (or even hints that they will) between now and November. That is is the crux of the conspiracy theory: The thought amongst most traders is that just like last autumn, Jonas has somehow already seen the Federal Reserve's Playbook and this trade isn't an educated guess, this is a trade executed because he knows. Though Jonas doesn't have Blankfein or Gross status in the sense where they have been rumored to sit with Bernanke and Co., it doesn't seem out of the question that he may actually be involved in policy discussions concerning the Fed Funds Rate. He may not have a real voice or a vote, but to simply be a fly on the wall would be a highly profitable experience. Now this is probably just hearsay, but ask the pit locals if they would want to be naked short November Futures and you'll probably hear a resounding NO. Dig deeper and you might get some more of the growing Jonas lore. 

Again, I have no idea of this trade is simply a hedge for the ED complex or perhaps he has accummulated a large short position in November and he is simply trying to finance a trade that's losing its luster. But then again, does it matter?

~LH

Down but still chugging

What we had believed were easy layups last Wednesday (previous call), has turned out to be quite the difficult set of trades. We had been looking for a hint of optimistic news coming out of the Humphrey Hawkins and got very little market agreement. By optimistic, what we really anticipated was some type of hint towards further liquidity draw downs or some other signal that the historically low targets were going to finally start to climb back to normalcy.

Our gold stop was too tight. Though the play was exactly right, we didn't allow enough room to wiggle towards the downside and it cost us a winning trade. Looking forward, we would like to try a two week gold trade with a bit more slag in the line. We initiated longs at 1116.50 in GCJ10. Our target is 1145-1155. Our downside trigger is 1095.50 and our allotted time is 10 trading days.

We have noted the VIX (Yahoo!) here before and we like to use it as a gauge for some of the option plays we execute. It's currently trending lower and if the general market continues to grind higher, we anticipate multi-month lows. Our play to capture this as well as a perceived top on the SPX is to sell ATM calls. The trade we like is the SPX J1105 call at $16. If we trade higher, you have 16 ticks to hedge your shorts, but if it is the grind higher (a tick or two a day) the locals will extract a pound of flesh on the ATM Volatility (currently about 18%). Our thought is that there is a minimum of 10-15 ticks to the downside and wouldn't be surprised to see a 1095 print by Monday at noon. This is strictly a 1-4 day trade and we'll be looking to cover if we start trading south of 1090.{This has been a painful trade and even though I agree with it in principle, we're going to need to cover all of it. Though not the optimum way of doing it, I bot all my short futures in at 1120.75 locking in a loss and I'll have to stay alert for a huge sell off. I'll probably buy some puts to lock away downside risk. Not our best trade}

Our U/U trade has been beaten up. Our longs were initiated at 27.50 and over the last two days it has traded as low as 24. We have added to this position and continue to look for a push back towards to low 30s. Our averaged price is now around 26.

Finally, Mr. Practical Thinker has put his devised a spectacular, end-of-the-world, insurance policy (PT: you should expound on this strategy and why it is so dynamic)

Buy FFJ10: 9984.5

Sell EDH10: 9973.75

We would recommend the normal ratio of 6:-10 which is dollar flat.

Hopefully we get the moves we've been waiting for. Enjoy the weekend. 

~LH

Finishing off February

February is finally over. Now what do we do?

Photo Op explanation

In an attempt to actually back up my claims of longevity, I've added a photo to the header of this page. Though to be honest, I'm not sure if your belief in my story is actually something I desire.

The picture fits a few trading metaphors. Some are more popular than others and some are simply those of my colleagues on the trading desk. I want to explore a few of these and how they play into my psychology and temperament.

1. There is so much _____ (money, assets, wealth) on the side lines.

• Mr Practical Thinker, often mocks this theory. His logic is as follows: If you own stock A and sell it, what are you going to do with that money? Buy another stock (not on the sidelines), exchange it for another asset (buy a house or a boat...again, not on the sidelines), or throw it into the banking system where they get to use it (not on the sidelines). Unlike the little guy pictured here, he doubts that such a system really exists.

2. The grass is greener on the other side of the field.

• This is a truism on so many levels. Whether we're talking about markets, women, or opportunities, the best ones are always the ones we wish we were involved in. However, in a grander scheme, they're all just a football field. Some might have been maintained a bit better, watered more, perhaps even had some artificial upgrades, but when it comes to the game (in this specific illustration: trading) the field is just a field. We play our game and go home. Nothing more. There is may be a better field somewhere else, but the illusion has made many a trader leave the market they know and love to chase the ones that look greener...and then I came back poorer.

3. It's a marathon, not a sprint. Even this little guy (in the photo) will get across the field eventually.

• As in investing, that marathon approach has never really appealed to me (yes, I understand the compounding of returns, but still). As in trading, that is the phrase I use when I'm booking a lot of losers and instead of trading them, I have just simply stuck them in the position to deal with later.

4. Your progress should be as constant as the yard marks on a football field.

• This makes sense to me. If your results are consistent and easily tracked, you have a replicable system. If you're erratic and following your logic is about as clear as mud, you are just monkey throwing darts. My goal is to always have the process right and then rely on the counsel of the guys around me to trade it well. I want people to be able to look back and say they understood the trade and the reason I'm out of it.

5. Guarding the Left Hash.

• This has been my motto for some time now. As a scout team linebacker in college, I was an expendable body that could be put almost anywhere with very little recourse. During a frustrating mid-season practice the Offensive Coordinator finally snapped and sent the entire offense on a disciplinary lap (the was quite the painful experience for 300 lbs linemen). As they jogged, the scout defense was given new 'assignments'. Apparently, I wasn't a) very good  b) very important  c) not going to ever be able to give them a good 'look'  d) painfully slow  e) all these and more! My job, as it was described, was to just 'Guard the left hash'. Rather than take offense, I made it my job in life, to never be that disposable again. I fought to be irreplaceable and to always walk with my head up so that my crown didn't slip off my head. Some thought I was arrogant, but confidence looks very similar to those that have none. So for me, Guarding the Left Hash is the maturation of a scout-teamer into a trader and all the swagger that goes with it.

Finally, my market is saturated with powerful spreading algorithm traders. These boxes are lightning fast, accurate and self correcting. It is impossible to 'out-quick' them. But they have a serious flaw, they don't reason like we can. Granted, many of them actually "see" more of the market than we do, but they can't differentiate from the puke and the panic buyer. I think that there is only one real advantage we still have over the trading skills of a computer. That is our ability to know ourselves and to trade with a pure, unadulterated opinion of the environment surrounding us. An opinion formed on the back of a lot of hours, a multitude of paid 'dues', and the belief that we have matured and have no problem Guarding our Left Hash.

~LH

Crash and Dash

Here's what we had and covered:

• Long US from 116.25 out at 117.23 (Old Baron's call)
• Short SPU from 1108 covered at 1094 (Mr. Practical Thinker nailed this one)
• Short the AUD from .9000 from the overnight session of 2/22-23, covered at .8895 (Mr. PT again)
• Long the ECH10 135.85 from 248. We are looking to sell this out entirely for a fractional winner
• Short EC at 1.3585 covered 1.3520
• Short CLJ10 from 79.875, we were almost stopped out at 81, but it held and we covered at 78.855

Initiated the following:

• Our much beloved U/U (Fed Funds vs ED) is back in play. We're long from an average of 27.5 targeting 31
• In the ED we are long the U/Z futures spread from  30.5 targeting 35.
• Long GCJ10 from 1104 with a tight downside stop at 1097 and a target of 1127 {Got Stopped Out in the overnight session on German comments about not helping the Greeks 2/24}
  
• SPX H1050p, we would recommend a very short term trade of shorting this put. Look to cover within 48 hrs.{{We bot the H1075p for 10.00, effectively locking in the 1075-1050 p/s for $2.00. There is a gap from 1074 to 1093 from Feb 16th and we will be looking to capture the retracement as well as a bit of follow through. That p/s is currently 3.25-3.65 on settles 2/24}

Guarding and Grinding

At times the environment is simply conducive to the aggressive, long style trading that I've grown accustomed to. Most of my grinding comes in the form of 'Micro Interest Rates' (usually Fed Funds and Euro Dollars) and a surprise move in the discount window Thursday created a porthole of opportunity to press the positions I felt as if I'd been milking for so long.

Hindsight trading is 20/20 and as usual, I wish I'd emptied my entire holster on Friday afternoon instead of holding back the last few rounds. In talking with some of the other traders around the desk, they too all expressed a feeling of lament for being reserved in their efforts. Yet, there's something to be said about that bit a reservation. It's that piece of me that has probably produced some of the longevity I've enjoyed through my trading career.

I discussed some of my early trading venues in an earlier post, but I didn't truly earn my trading stripes until I stepped into the Bond Options pit at the CBOT as an autonomous local. This pit, more than any other, taught me to press a winner but to never be without bullets.

It was the spring of 2005 and the volatility was getting cheap. Though none of us were clairvoyant, we could all feel a trend starting to develop. This trend would continue for almost 3 painful years and would encapsulate nearly 20% of the all-time low month/month volatility readings including a mind boggling 4.2 print in August of '06. {Historical Vols} But this is the place where I learned to watch the few titans amongst the our pit locals.

These "3 Kings", as I'll call them, were traders that would never sell premium on the first pop, rather they would sit back and watch what real paper was doing.  They all possessed that unique ablitiy to fearlessly buy it higher and sell it lower. As if they were all taught by the famed Jesse Livermore (Reminiscences of a Stock Operator), they never saw it as chance to empty their pockets when the first bid appeared. Rather, they were the ones buying it (usually through the pit brokers) from all of the smaller locals, myself included. Not that I wasn't happy to sell my book for a perceived profit, but it confused me as I watched the 3 Kings books swell under the immense weight of millions of dollars of gamma.

Then it happened. The real paper showed up. Not that small retail customers deck, no, these were the big houses that had to move a position. I suddenly learned an enriching lesson: real paper is 'price-insensitive.' They needed the options and they were willing to pay up in order to get them. Guess what, I was fresh out of bullets. I had let go of the options I had stomached as losers for the last 2 months, and for what? 4 extra ticks? It hardly seemed worth it. Yet there, across the pit in their own corner, the 3 Kings continued to bid premium in the face of paper. The unthinkable occurred next. It was like a game of chicken and PIMCO blinked. Their bid jumped 10 ticks and the 3 Kings unloaded the wagons. They dumped every bit of the longs they'd gobbled from the locals and in the process they even offered all the little guys around them a chance to get some real edge. They had created a marketplace and they had dictated what the price would be.

My first game-changing lesson was complete. I saw that if you sell on the first pop, you haven't guarded your longs and now you may miss the real trade. I would have plenty more opportunities in the next few months and years to practice this skill and ultimately refine it to the point I felt comfortable pressing it. The real mark of a learned skill is the ability to teach it to others...but that's another story.

One down. A multitude left. And as I finish this, I realize that my holster is re-loading quickly.

LH

Tapping out after the Fed Announces

• Unloaded our NOB (sold US at 116.18 and bot TY at 117.06) and collected another 883 ticks
• Scalped the SPU's like champions and looking to dump it for the weekend
• U/U we actually sold it too early and missed the 36s but enjoyed a nice pop nonetheless
• Never got a chance to sell the AUD
• The EuroFx has sat around pivot, even with the swings, it hasn't broken out of our ranges

In a giant bubble

My friend and colleague Mr. Practical Thinker had some fascinating points on his view of the current global market place and debt crisis {Mr. PT's blog}. Though my thoughts are probably not able to add new revelation on his ideas, I do think it's important that we look to see what paper (JPM in particular) is doing to cover their risk is just one tiny sliver of the market.

As an avid follower of the yield curve and its largest participants, I always find it fascinating when paper decides to do something that is strange AND expensive.

Many large institutions have been selling May and June strangles in the Ten Year Note (TY). This is a common, quarterly occurrence and includes the likes of PIMCO, JPM, SSB, and ML. Understanding why they do these strangles usually has to come from the gaze of, "We need to add return X+1.5% (yield enhancement) on our mortgage portfolio, how can we accomplish this?" Commonly, they will sell a strangle to help bolster the bottom line. (i.e. if you were to sell 100 June 115-120 strangles at 36 ticks, you would receive $56250)

This strategy can be especially advantageous if you are long a basket of bond-type instruments because this will offer you a forced sell on the upside (short calls) at higher prices than you purchased and a forced buy on the downside (short puts) at levels that would average in better long term costs.

Today, JPM decided to do the opposite. They actually spent money and have been doing so for the last few trading sessions. They have now purchased roughly 12,500 June 123 calls for an average price of 5.75 ticks. This trade represents a 1.12mm insurance policy just in case the world decides to go bonkers. If the Greek debt crisis explodes or if the Russians default again or any of the other random, fat-tail events (that one of my heroes Nassim Nicholas Taleb writes about) actually occur.

As a local thinks: These are airport options if you sell them. Either you're going to the airport to take a fantastic trip because of your immense profits or you're headed to the airport to get out of town before your clearing firm figures out how much you've lost! Either way...you're headed on a trip!

Updating the MGC (Monday Great Calls)

Here's the update going into the PPI data tomorrow and Friday's CPI.

1. Closed out the UL vs TY spread at 120.21 and 117.205. This trade netted 1007 ticks ($31.468.75). In its place we've intiated a very basic NOB. Re-initiating, with the US 63 @ 116.27 and sold the TY -100 @ 117.205
2. Buy premium, the VIX is too low. (See SPU section #6)
3. Hold on Euro FX positions
4. Look to sell the AUD over .9050
5. Currently Long this U vs U spread and looking to sell 31s
6. Purchase the 1095 SPX straddle for 12.40. Look to hedge below 1085 and above 1115
7. Neutral. Flat CL after getting to the expected target.

 My gut says that the PPI & CPI data (Bloomberg Calendar) will be a complete duds and the overall market will slowly drift towards unchanged for the week.

LH

Monday Mornings are for Great Calls

Here's my play book for the week ahead. We're actually closed Monday so it will give you a bit of extra time to digest what you'd do with these.

Plays for the week:

1. Using the new Ultra Long Bond (UB), I would like to put on a BOB (UB vs US) vs a NOB (US vs TY). Broken down, the US portion actually cancles itself out and what you're left with is a Long UB position vs. a Short TY position. Here's the ratio used: +28 @ 121.25 UL and -130 @ 118.04 TY
2. The VIX is simply too high (currently 24.05). Expect the VIX to settle around 22.5 on 2/19/10
3. Euro Currency. The previous week has been a roller coaster and there is little doubt this will continue. It should stay between 1.3350 and 1.3850 as long as the Greeks keep up their end of the bargain (currently 1.3590).
4. The AUD is the personal favorite risk currency of my associate Practical Thinker (Mr. PT for short) and his call for this week is to remain between .8750 to .9050 (currently about .8840)
5. Expect the Eurodollar vs Fed Fund Sept 2010 ratio to remain in a very tight range of 31 to 32, buying dips and selling spikes (currently 31)
6. Expect the SPU to hang tight inbetween 1050 and 1090. However, a violation of the 1095 line will mean higher highs (currently 1073)
7. Finally, the Old Baron in our office has proclaimed that oil (CLH10) is a screaming buy and will settle on 2/19 right around 77.50. (it is ~$74)

This is the playbook. If this week somehow produces a market moving catalyst the play will be cover or take profits sooner than Friday. I don't anticipate any of these positions lasting for more than a week. My gut says the world is just a touch to dynamic.