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

Execution that hurts

Yesterday, on the 1.25 point sell off in the US {30 year} we decided to play the 'mean reversion' game and take a shot at getting long some upside calls.

We purchased the December {Z} 137 calls for 20 ticks. Our motiviation was as follows:

1. We are currently at the 60 day support level in the USZ {roughly 130}

2. We are anticipating a stock sell-off as well as the corresponding bond rally following next week's supposed QE2 announcement.

3. A trusted adviser taught me that when all else fails and you have no idea what to do, buy gamma.

{they're currently priced at 11-12}

Other things we've done or rolled out of.

1. We have taken 75% of our E0X 91-93 put spread off. We purchased it for 3.5 and have sold it for an average price of just under 5 ticks.

2. EDU v FFU, we purchased 28.5s in the spread and sold 31.5 and 32s {completely exiting the trade}

Finally, my Philosophical rail Defender alerted me to the following theory about the Nov 3rd announcement. Fascinating opinion. {this text comes directly from an IM conversation}

So here is my 10 delta prediction, {we'll get} no explicit announcement of QE, stocks tank, PIMPCO takes it on the chin and puts back {their long book of} MBS to Bank of America. The Govt does a Citi/GM style bailout with BAC. {As a result} Geithner gets ousted {and either} El Erian or Gross will move into the drivers seat at Treasury. They will then propose a bailout of state pensions via the Treasury issuing 100 year bonds at 6 pct in a swap for all pension assets. Then the Fed continues to stealthily purchase everything not nailed down.

~LH

Get Long {might be wrong}

Our markets are slow and getting increasingly cheap. A few thousand contracts here and a few hundred over there is about all we're seeing these days. ED volume has fallen to new lows in total contracts traded. It's as if the world is in a post Thanksgiving induced coma. It has been fed cheap money in infinite amounts. Now as it lays and tries to digest everything, its being lulled to sleep in an environment of sinking volatility.

I'm seen this movie before, somehow it always ends in tragedy. {However, it is only painful if you are caught holding the potato when the music stops.}

Few of the things we would like to do.

1. ZH diagonals in the TY and US. I would like to grab some cheaper gamma and finance it by selling wings. Ideally, we would like to do this with puts. Our medium term outlook {3-6 months} is that we'll stay range bound in the yield curve with moderate moves within the range that will help you to finance your decay. {Z28p v H21p gives you positive 6.5 gamma for 2.75 ticks of decay a day}In the event of a credit meltdown, we suspect the bonds will go higher, making a short longer dated call a risk to your overall position.

2. In order to capture the 'cheapness' of implied risk, we think that you're best served putting on steepeners across products in FF v ED {sell the ED and buy the FF}. Of particular interest to us is the EDU v FFU. The spread between the two of them has recent traded at its low {28} and it provides a couple of plays as we go forward. a) if the world ever gets frightened by credit risk, European or American GDP, or some other nascent economics flag you'll most likely see the EDU react in a much more violent way then the FFU. b) under current decay models, the EDZ v FFZ is at 17 with a QE2 bump priced in. This means you have a pretty solid floor at -9, though we are looking at a stop around the 24 range and an anticipated exit at 40.

3. We still like being short the NOB. If you can stomach the stress, it has a long way to fall back towards reality.

~LH

No text, just a cartoon.

 

for a bigger, cleaner, nicer version go {HERE}

~LH

Big Ben needs to be susupended

So, did you enjoy Bernanke's speech this morning? Jan Hatzius didn't, at least from a 'we need QE2' standpoint. His comments:

From Hatzius:

BOTTOM LINE: Chairman Ben Bernanke adopts a cautious approach to his speech, reiterating that he sees a case for adopting more stimulus but that any decision depends on the costs and benefits of the nonconventional policies. The speech contained few details of what form additional easing could take, although Bernanke clarifies that he regards additional asset purchases and/or a tightening of the FOMC’s guidance language as the primary tools. Overall, the speech is consistent with our expectation of a QE announcement in November.

MAIN POINTS:

1.       Chairman Bernanke re-emphasizes the FOMC’s dual mandate of attaining the longer-run sustainable rate of unemployment and mandate-consistent inflation. With regard to the former he argues that “the bulk of the increase in unemployment since the recession began is attributable to the sharp contraction in economic activity … rather than to structural factors.” Bernanke thus refutes the idea that labor market mismatch has pushed up the structural unemployment rate significantly.  Given this large amount of slack, Bernanke notes concludes that “it is reasonable to forecast that underlying inflation…will be less than the mandate-consistent inflation rate for some time.”  The tone of this speech is consistent with the "bite size" approach to asset purchases that we have come to expect in the wake of earlier speeches rather than a "big bang" approach.

2.     Given this deviation from the FOMC’s mandate he argues that “there would appear--all else being equal--to be a case for further action.” However, Bernanke is careful to stress that “possible costs must be weighed against the potential benefits of nonconventional policies.” The chairman provides few specific details but clarifies that he sees asset purchases and forward guidance as the primary unconventional tools too boost the economy. His remarks contained no comments on price level or nominal GDP level targeting.

Summarizing a complete conspiracy theorist:  Jan is saying that Ben will NOT be doing QE2 and in the process he'll "preserve some of the Fed's mystique".

I would a love a non-event QE2. Either the kind where the Fed says, "we're going to do $1 Trillion in easing and oh yea, by the way, we've already done $500 million-ish" OR the kind where they say, "you know what, we are seeing some good data leaking out of all sectors and that means we don't need stimulus!" If this was to happen, I would imagine a 2 day correction in the S&P of 5-7% with a one week target of 10-12% bottom line support. That would help explain some of the current pricing and fear in the S&P combos that are currently priced at 3.7 to 1 for the put. {ie vs 1170 in the SPX the 1075-1275 combo cost 10.75 to the put, $14.75p v $4.0c}. Market makers aren't going to let you just get long downside OTM put for nothing, you've got to pay a hefty sum for the rights of protection. Baby steps to November 2nd!

One "Ben" just came off of suspension, the market will be calling for the other one be suspended if QE2 doesn't happen!

~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

Wyoming {Devil's Tower}

I got this picture from one of our brokers this morning. His comment is the caption. The crappy artwork is mine.

3 MONTH ?

~LH

NOB and CTD

This is our custom made graph showing the current Cheapest to Deliever (CTD) 30 year yield vs 10 year yield as it relates to the cash markets.

Though our CTD chart shows the NOB at 144, the spot future NOB (CME traded) is only at 134, this tracks the two spreads relationship to one another.

A weekly chart of the generic front NOB contracts dating back to September of 1992 along with the 50, 100 and 250 simple moving averages

The NOB continues to make multi-month year highs as the shorter end of curve sprints towards zero. I pulled up the generic front future NOB and asked my Bloomberg for the high, the low and the mean for the time frame 9/92 through today {10/8/10}. We're at the high, as in right now it is creating a new high water mark for the 18 year period. Historically speaking, we're 100 basis points over 'average'. I understand that we're in a new and "exciting" time but I have to think that some type of retacement is necessary. At a minimum, how can we structure a trade that allows us to risk limited premium and yet capture unlimited returns as we crash back towards normalcy?

~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

Booking Expectations

The addition of the newest office member has added an exponential increase in our trade idea generation. Though we have been substantially quiet in many of our markets, it hasn't been for lack of ideas, rather we're experiencing a total lack of conviction. As I type now we're in the midst of another spectacular bull session for the Euros. LIBOR has downticked to a paltry .28906%. In the last 15 trading days, the Green December ED {2012}has rally almost 40 ticks. The expectations of long term QE are all but assumed to be relevant from now through the 2012 calendar.

We're stuck with the questions of how profit in the zero interest rate vacuum. How do craft an option play that capitalizes on the market's perceived risks {that the market continues to drift toward zero? Over the past few days large ED customers have been buying thousands of EZ2 9925 calls at 1 {>30K}as well as the EZ2 9900-9925 call spreads at 4.5 and 5 {>40K}. Seriously!?! That's 40 ticks away and has 65 days til expiration. That's unbelievable. Though given the the last 15 days, it doesn't seem like much of a stretch huh?

Now we're drifting higher in price, lower in yield. The markets can't keep rocking higher, can they? What happens when QE2 gets released?

One of the more poignant arguments I've stumbled across lately is in a Bianco research piece. This piece focused on the amount of QE2 and hinges off of a Bill Dudley speech recently given to the Society of American Business Editors and Writers. Dudley stated that "$500 billion of purchases would provide about as much stimulus as a reduction ion the federal funds rate of between half a point and three quarters of a point." They then surmised that Dudley reached this conclusion by using the Taylor Rule to approximate a neutral funds rate.

"Using core PCE as a measure of inflation, the Taylor Rule places the neutral funds rate at -1.50%...With the fed funds rate essentially at 0%, the Federal Reserve has used asset purchases as a means to further decrease rates. These purchases have created almost $1 trillion in excess reserves as of 9/22. Taking Dudley's statement at face value, $1 trillion in excess reserves has already pushed the "implied funds rate" to somewhere between -1.00% and -1.50%. A further $500 billion in QE would push the rate to somewhere between -1.50% and -2.25%." {http://www.arborresearch.com/biancoresearch/}

Ouch, especially for our market. Maybe the large ED customers have read this idea too and are hedging best they can. Can you actually get negative interest rates?

~LH