One play for today (3.31.10)

Haven't written in awhile and I feel naked. Let's open the playbook. Who has an idea to pitch me?

ANYONE?

• Bonds: I'm looking for a sharp down draft (lower prices, higher yields) on Friday's Unemployment data. Wednesday's ADP data was shocking to say the least. The market gurus were predicting an increase in hiring (not a loss) and are also whispering about a +200-250K job number this Friday. I don't think that +200K will happen (Bloomberg wants +181K), but it could and the 'Census Hiring' could be the determining factor. Due to the run up in Yield Curve Futures today we were able to buy the Ten Year 113.5-114.5 put spread in May for 7 ticks (TYK 13+/14+). (Updated: 4.2.10: The Unemployment Report broke us a bit lower. We looked at and discussed the possibilities of rolling it into a NOB. However, the yield spread between the 10's and 30's is not at a level we felt comfortable initiating. Therefore, we simply sold our entire position at 12 ticks. Netting 5 ticks of profit)
• You have 2 plays with this spread as we cruise lower. Sell it out and take your 4-5 ticks OR sell the May 112-113 put spread in the BONDS on a 100:-65 ratio (ie sell 65 Bond spreads per 100 Ten Years)
• Option 2 actually allows you to collect a small amount of premium and to effectively have an NOB (Notes over Bonds) yield spread play on. 

~LH

Quoting Pixar

Some weeks are harder than others. Last week was one of those weeks. Whether its the difficulties of a trending market or perhaps the pinch of repeatedly bad settlements it is with eager anticipation that I look forward to this new week. 

I desperately need to get Mr. Practical Thinker to write a piece or two on here. However, until he does, I will continue to poach his macro-mindedness and translate it into something we can all glean wisdom from. 

"You provide the food, I'll provide the perspective..."  (Anton Ego, Ratatoille)

This is not the first time I've stolen a line from Ratatoille (shameless plug: rent, borrow or buy this movie because its dialogue is supreme) and I hope broaden my "quotage" in the weeks to come but for now, you're stuck with the genius of Pixar. 

All this to say...the rumor-mongers and Mr. PT have done some adjusted my thinking by providing the perspective. If you've been following our execution you might have noticed that one trade we've gotten consistently right is our NOB (Notes Over Bonds) where we have sold the yield spread as it approached 100 basis points. On Friday, the spread between the two dipped to (and closed at) 89 bps and I desperately wanted to get long for the ride back up. 


The discussion was poignant and chalk full of salient information, but there were two quotes that I absolutely have to put on here. 

"I want to stay in a trade until it is blatantly obvious that I should have it on the other way"

 Two weeks ago, the NOB yield spread was trading 98bps and we sold it. If we (US) are really heading towards slightly higher short term rates and a better overall economic picture, one would expect a flattening yield curve. Why would we be in a hurry to tap out of at 90 or for that matter get long hoping to chop the last few basis points off of the giant's spear? Given where we believe the curve's rates are headed, we should have bet the farm at 98, looked to continue selling at 94, staying alert for any type of momentary blip while we continued to sell it until the 3 month low of 82 is taken out or we're so ultimately convinced that it is heading the other direction that we're forced to cover. Why would I give up on the right play? I think the answer lies within the Old Barron's wisdom of quote #2:

"It is so hard to stay long a winning trade, especially in this current trading climate."
That is so true. We're currently an office of grinders. We sit and grind through spread after spread, buying and selling both bids and offers while trying to not internalize to much of a position. Our ability to see the next tree and articulately describe it, inhibits our skill at seeing the actual forest. We are miss the global plays because we have our heads down and are furiously working at pounding out ticks. Though there is great wealth in "the grind," my guts says that the real money is in the being able to identify the trading climate you're headed towards and position yourself appropriately. Our tendency with winners is to close them out as soon as we've reached the maximum we were willing to lose. But trading isn't a bell-shaped curve. The best trades are great even if they retrace a bit and cause you to re-evaluate why you got into the position in the first place. Does the this particular trading strategy still hold water? If yes, you'll have to resist the temptation to close out and risk your chips a bit longer.


Needless to say, I didn't NOB it up. I'm actually flat. 


~LH

The tales of the tape

I've been called a bunch of stuff during my tenure as a trader (most of which are not postable due to the explicit nature of the floor). I have a thick shell and frankly nothing really stuck...with one exception. I've been told that I gossip like a school girl and can not pass up a good story, especial when it involves trading.

Today was my lucky day, I got to hear two fantastic tales from fellow traders.

1. Chicago is the home of some of the industry's powerhouse operations. Some you know because of their reputations, others you might have seen advertising on TV, and others you know only because of their secrecy . This is a story about one of those kind of firms. These guys swing a big stick, have an ultra cryptic black box, and have been having a really rough go of things lately. In fact, through February these guys were down a whopping 16.5% on their flagship fund. Suddenly, the stars lined up (quite literally, as it has been rumored that they use employee's astrological information in their black box calculations). In the first 13 trading days of March they rebounded a shocking 29% including a 5% move TODAY. Seriously? You made 5%, today? ON WHAT?!? And wait a second, what is the beta on this portfolio: +8? Yet this trader was lamenting that even though they have just slaughtered the market (and their competitors) they are liquidating all non-essential assets. The house out west, the satellite offices around the 'burbs, even the gorgeous tropical fish aquarium in their high-rise loop office have been sold, closed, or flushed... The returns might be rosy today, but his fear (and mine too if I was an investor) is that: any thing that can appreciate 5% in one day, can depreciate equally fast. I casually asked him what sort of risk parameters they were using, if they were incorporating options in their strategies, and whether or not they (the traders) actually had any autonomy in what they were trading. His answers were baffling: No real idea (risk), No they're too costly (options), Not really--we just trade what we're told. Wow. The moral of this tale is: be careful where you invest even if the shop is local.

2. Today was St. Patty's Day and as I was enjoying a beer with some of the neighborhood folk I ran into a kindred spirit: an option trader. He trades for one of the largest, highly respected, money-making firms in the industry. They have traders on all continents, in every major trading location, and in almost every pit where there's money to be made. He admitted that 2009 was a very difficult year for him as well as the firm's floor operations. Supposedly, it was so bad that Christmas bonuses were scrapped. However, a majority of 'W2' traders are paid a relatively low base salary and receive between 33-50% of their total compensation via a year-end discretionary bonus. Yet this firm is spending millions to upgrade their office facilities. MILLIONS! The trader I spoke with said that he felt his meager bonus was negated in favor of the company's lavish new digs. In fact, he claimed that they lost over a dozen pit traders when ALL bonuses were canceled, even though some of those traders made the company so serious money (I'm guessing that some people must have been negative too if it was a difficult year for the floor ops).

These stories tell tales from two different ends of spectrum, but there's a twisted humor in both of them. Hopefully, both my acquaintances will manage to trade out of their current spots.

~LH

Semantics

OK, guess what, I was wrong the on the change in wording (#9 from my last post). They made a few minor changes, but to be honest it is window dressing and it feels like they (the Fed) is trying to tip-toe around the markets.

 Here are the highlights that I enjoyed:

LABOR MARKETS
    January: "The deterioration in the labor market is
abating."
    March: "The labor market is stabilizing."
  
ECONOMIC CONDITIONS
    January: "Household spending is expanding at a moderate
rate but remains constrained by a weak labor market, modest
income growth, lower housing wealth and tight credit."
    March: "Household spending is expanding at a moderate rate
but remains constrained by high unemployment, modest income
growth, lower housing wealth and tight credit."

DISSENT
    January: Kansas City Federal Reserve Bank President Thomas
Hoenig dissents, arguing that pledge to keep rates at
exceptionally low levels for an extended period is no longer
warranted.
    March: Hoenig again is the only Fed official to dissent

Nothing changed... well, I take that back. The outrights shot higher and the spreads conversely collapsed.

Points of interest:

• The Fimat desk continues to sell 50/56 and 56/62 put stupids in November. They also have started buying the 68/75 and 68/81 call spreads. IN MY OPINION: This is almost an identical trade to the one they executed at the end of last summer. Obviously, I have no idea what they had against it (the earlier trade) as a hedge, but if it was a stand-alone Fed Funds trade, it could have grossed a whopping 35mm. (notes from 2/28). 
• The long end of the yield curve (30s) has experienced a "volocaust" in terms of the options markets. The 30 day moving average of the underlying (USM10) is tracking around 7.5% and the options are equally as cheap. It is probably about time to get long June or September volatility. 
• I spoke with a few Energy traders this week. They all told me the same story in slightly different terms. After a really rocky '08-'09 for the Natural Gas vs Crude Oil trade, a lot of traders jumped back into it at the start of 2010. Everyone was betting long NG (because it was cheap) and short $80 Crude. However, the rise in Crude and the collapse of Natty has been a costly trade. In order to cover their losses, they've simply sold their long Nat Gas and sold more Crude short. Eww, sounds like a painful to me. (Crude is up almost $2 as I type this)
• The SPX has broken all resistance lines and is headed to 1175. I'm indifferent but need to cover some cheap puts around the 1115 line
• The NOB is at 94 bps. {aka "no man's land"}
• The Dollar looked horrible today... and the 'impending news' about Spain has never materialized
• EC continues its bullish run back towards the 1.40s. If you look at the chart on a 1-day time interval, it appears to be building the foundations for a firm support line around the 1.35-1.36 area. 

Until they're all winners, trade away.
~LH

The Practical Thinker has escaped

He got away, even if it was just for a little bit....

Maybe next time, it will be me.
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1. The SPX's has rolled to June being the front contract. Roll down our strikes by about 4 pts. We still haven't executed a 2x3 or a combo but we're waiting in the weeds.
2. Gold has been angry...wait, just wait. 
3. The EuroCurrency has been strong all day paving the way for most major currencies against the Dollar. 
4. Rumor has it that Spain has a bit of a problem coming out soon...the currency market doesn't seem to buy the hype. Premium in the puts really took a beating today.
5. The NOB has come all the way back to 92 bps...we'll be waiting to reload
6. The long end of the yield never got low enough to sell any put spread
7. Our E0J put 1x2 was 5.5-6 on the break this morning on the Retail Sales data, but leveled back off settling around 4.5
8. Next week is very busy with Industrial Production, FOMC, LEI, Philly Fed, PPI and CPI. 
9. I fully expect the Fed to drop the 'extended period of time' language as four presidents have now openly criticized it. 
10. The Fed Funds cash market was 17-22 this morning even though the month's effective is only 15...just food for thought.
11. Next Friday is a quadruple witching with no numbers. Don't be absent. Something surprising always happens on no-number Fridays, especially when you have a lot of securities rolling off the books.

Enjoy the weekend: Mr. Practical Thinker is............
~LH

Play card: 03.09.10

What seems like a good play right now? Interestingly we've been a bit scattered on our picks, and though we've avoided a lot of trouble, it hasn't been easy.

If you'll recall:

• We were stopped out of our SPX play and covered all short deltas. We haven't bought any puts back in, but it is on the radar.
• We're long gold. Greed may have gotten the better of us as we got near the 1140 handle. In retrospect, it would have been prudent to place a stop around 1135. We didn't, and are still long. However, I've moved the stop up to 15 ticks 1110.{Stopped out 1110.50 on 03.10.10 we were off by 5 ticks!}
• Our U/U was brutally difficult to trade. After buying 24s and selling 27s a couple of time we were able to get the unit costs down to roughly 24.5 before getting flat at 28.
• The 'end-of-the-world' trade with FFJ vs EDH hasn't really paid off, though it is getting back to our levels and we would maintain a hold.

If you want to check on any of these click here.

Where does this quiet economic week send us? There are a few auctions in the yield curve however, the only piece of real data in my opinion is the retail sales number expected on Friday. Going forward, here where I'm focused.

• We're looking for a drift lower in the yield curve (though today's 3 year notes did fairly well at auction, drawing 1.437% with ~15% allotted at the high). If the long end (30 year) can below 115.28 we will be looking to sell 25 delta put spreads. Perhaps the 109-112 or the 110-113. 
• As the SPX continues to grind higher I can't help to get more and more bearish. However, after being stomped out of my last position I need to find a better way to express my opinions. Two plays come to mind: Short ratio called spreads and long cheap combos (risk reversals) 
• The J1175c-1200c call spread on a 2x3 ratio. You'll collect $7.35 (8.85 and 3.45 respectively) to sell the 1175 x2 and buy the 1200 x3. This provides you will a long premium play and a fat tail for protection.
• J1090p--J1190p is currently trading 3.60 to the put. That feels really cheap. I would look to be a buyer around $3.00
• The NOB spread is currently .98 bps. We sold the TY at 117.035 and bought the US at 116.17 on a 10:6.6 ratio {We reduced our exposure by 50% after netting 225 ticks, we plan on taking the balance off around 94 bps 3.10.10 UPDATED2: We traded completely out of this position buying 116.195 and selling 116.03}
• In the Eurodollar, I like being long high-octane put spreads. E0J 78-82 put 1x2 offers me that opportunity. It is priced off of the EDM11 (currently 9844.5). It costs 3.5 ticks and has about 6 weeks left. It break-even at 9821.5 and begins to lose money after 9784. This gives me 37.5 ticks to collect a profit.

 A few closing point lifted from my cohort in trading Mr. Practical Thinker:

1. Australian Unemployment is released tomorrow evening at 6:30 CST. This may finally be the catalyst that brings the AUD above .9225-.9250 and may provide an immediate term trade to get short looking for a retracement back to .8700

2. The chart here is of the SPX on a one week basis. Though it may be a bit difficult to read, it would appear to us that we have now ground through the free-fall area of October 2008. If we seriously get through 1148 which was the high set back in January, I would expect us to get up to 1175. From there, the next stop is near 1200-1225 (thus the 2x3). Failing to crack that 1148 level would potentially send us back down towards 1100 (thus the combos).

~LH

You need to win 51% of the time...

I vividly remember being injured as a collegiate football player. I had finally won a starting job and I broke my thumb on the opening kickoff of game six. Nine days later, I had surgery, effectively ending my regular season. But the playoffs were just a few weeks away and as the #3 ranked team in the nation, I had just 2 short weeks to recover and find a quack doctor who would 'OK' my hand for game play.

Then losing happened. We lost to the lowliest team in our conference and were subsequently unable to rebound the following week against our fiercest rival. Our rank tumbled and we were shutout from heading to post-season play. I watched in disbelief as the season I had invested in crumbled beneath me.

I tell this story not to invoke sympathy, rather to highlight the struggle of playing a game where we don't always control all of the pieces. This isn't Chess, where all pieces follow specific rules and all participants (and observers) have all the information. Rather, it is like Stratego and the idea that collecting proprietary information, planning and strategic implementation play a huge role in the size of our return.

Losing is part of life. Sometimes we just get the raw end of the stick and are forced to trade out of it. I've found that being self-aware plays a large part in how I handle a loss. If my first trade of the day goes horribly against me, I know that I'm going to have to work that much harder to have a positive day. But there is another force at work. The internal anger from getting run over on the 'first play from scrimmage'  has the tendency to sideline me for the entire trading session. Realizing that I'm predisposed to trade poorly, I have had to develop the ability to stand back and objectively trade again rather than sulking at my desk for the rest of the day.

One of the partners in the first firm I worked for was Dutch. He had a bunch of interesting phrases:

• "Smoke whatever you  want and drink as much as you like, but if you come to work drunk or high I'll rip off your head and piss down your throat...then I'll fire you."
• "Understand that tanstaafl (there aint no such thing as a free lunch) is absolutely true even if I offer to buy you a meal."
• "The worst trade you'll ever make as a rookie is the one where you make a lot of money."

Those three may have been true, but the one that always bothered me was:

• "You only need to win 51% of the time"

I just don't subscribe to that logic. I believe the skill involved in being a successful trader is to be clairvoyant enough to know when your trade is going against you. You can lose 75% of the time as long as you cut your losers and press your winners. It is my experience that tells me I still have a tendency to do the opposite, even though I know what should be done. That is where I stand. I want to be the guy who can get hit in the mouth on the first play and yet still finish the game as though I was in All American form. My goal is to be able to take a garbage hand and finesse my way to a winner.

Punishment for the longs

Some of our long interest rate spreads are really taking it on the chin. Though it's frustrating (and sounds very cliche) this is an opportunity to get long(er). Over the past few days there has been a buyer in the inter-market spreads (i.e. a customer has purchased 8,500 May-July spreads and another has purchased 10,000 June-September) which leads me to believe that there is real interest in seeing the overnight rate trend higher as the Fed reduces liquidity in the system.

If you subscribe to the idea that the rates will have to drift higher (say from .12% to .20%) here's a thought on how to capture three meetings from the Federal Reserve and at least be 'set up' for that move.

We bought the July 68/75/81 put fly for 1.50 tics

If the Fed 'hints' at moving towards a more standardized target of .25% one could expect the July Future to begin the drift back towards 9975. Doing this trade in July gives you the March, April, & June meetings and minutes to spark a bit of rational thinking back into the market. Ideally, July will head towards 9975. You'll notice that the butterfly's two shorts are the 75 line. To maximize our return, we need to settle as close to .25% (9975) as possible. If that happens, we will net 425 tics per 100 lot (or $17,710). The max loss is 150 tics per hundred ($6,250) and this is realized fully with a a July settlement outside of 9968.50 & 9981.25. Three to one on your money, with a directional bias, actually seems to be the correct move. Merrill Lynch has also been a consistent buyer of this spread.

Remember, this Fed doesn't want to spook anyone and I think they will broadcast any type of change (to the language or posture) loud enough for all to hear. This means that they may hint to a language change, then tell you about a change that will happen, and the finally make that change. Capturing all three meetings for any (or part) of this scenario to play out is most advantageous. I'm sure most of  readers are familiar with the old phrase "Buy the rumor, sell the news." Hopefully, the trading community agrees and lays into the July as Fed policy starts to change.

It's going to happen: did you see Hoenig today...he wants to get these 0% rates moving too.

Rate plays for Down Under

Time to jump in the balmy waters of the Great Barrier Reef and taste a little bit of Australia. Practical Thinker has been snooping around the up-coming Australian rate decision due out at 10:30 EST. As usual, his homework is impeccable and his results...well, we'll need to wait about 45 mins.

Here's our trade:

Long the AUD from .8990

Target: .9070 {Sold out around .9040}

Stop: .8900

Start the clock, I don't anticipate a long wait on this one. 

~LH

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