Saturday, December 31, 2011

A 2011 recap using PFG’s trading indicators - 2012 - Buy shorted dated vol, get ready for risk-on via XLF and EEM.

A 2011 recap using PFG’s trading indicators - 2012 - Buy shorted dated vol, get ready for risk-on via XLF and EEM.

If 2012 brings a “risk on” moment via the elections, we could see money move fast into XLF and EEM.  We will be setting up the trade via upside baby calls.  If we get nothing, our 2013, 2014 short vol positions should pay us and a whale event will get caught in our long gamma positions.  It feels ok to pay a very little decay in 2012, which is something very rare for us.

1. 5yr EM vs DM and lookback vs owning gamma looks to have little downside (right to left) - Buy short dated vol/gamma.  Term Structure also at an extreme level to be ok short vega

2.  EM de-risking and risky duration, what will get money away from UST and back into risky assets? - This will be a big trade in 2012 for risk-on

3. Will 2012 Elections bring a bid into financials with a republican outcome?

4. Will correlation continue to stay high?

5.  Another support to own short dated vol, we entered into SPY Jan upside when the indicator was flashing 6.  Our options doubled in price, vol boomed and spot level is now ~5 (inverse to vol moves) - can it continue?

Friday, December 30, 2011

PFG Year End Performance + 54.39% Since Sept 2011

PFG Year End Performance

Implied Vol 14.08%
Watermark Leverage 16.8
Average Leverage 4

PFG Year-End Management note

We are still very early in performance meaning anything to actually project, since September however we have learned a few valuable lessons.

  1. Day Trading is very stressful and best left to machines/systematic emotionless folks
  2. Taking money off the table, entering trades should be done in thirds, no more, no less
  3. Risk management, over analysis of positions does payoff at the end in profit maximization.  
  4. Staying focused on your thesis, challenging your book everyday when offside by flipping it around and asking “what am i rooting for?”  Don’t ask yourself why your positions are losing, rather why the opposite book to yours is winning
  5. No way to remove emotions of trading unless you can allow a computer to trade your money and walk away.

2012 Themes

1. We continue to see value in Web Security Stocks and out of favor names


Web Basket + 11%
Out of Favor -13.5%

2. Hold financial upside calls for an Obama failure
3. Systematic Algo VIX Iron Condor Trading - Cheap Tail Hedge for a short vol portfolio
4. Enter into short vol trades on market fear

Thursday, December 29, 2011

OFF TOPIC: Canadian Housing Bubble - Two Stories, Commercial RE is very over-valued (40%) and Residential RE is over-valued by 10%

Canadian Housing Bubble: Two Stories, Commercial RE is very over-valued (40%) and Residential RE is over-valued by 10%

In fact, the Real Estate market in Canada has trumped Financials and even the countries staple - Energy

Try to find a bull on Canadian Real Estate, you won’t.  The housing market seems to have everyone upset about new highs being made everyday and bidding wars.  However, it’s not as bad as it seems on the residential side, but the CRE side is going to plunge.  REITs are very overvalued and it could easily move lower by 25% +.

Just have a look at the “For Lease” signs on commercial buildings in Toronto, Vancouver and Montreal.  Meanwhile, housing rental vacancy is sitting at very low levels. These friendly sounding stocks are no more then highly leveraged financial instruments that give the stock holder the worst slice of the debt. It only takes a small move in a lease loss or asset prices to fully wipe out the REIT holder. Hence the higher yield. The game is to pay real estate valuation firms to make "fair value" NAV prices and hence the banks don't re-value the loan and shareholders dont ask any questions. A forced slow motion margin call can turn fast when investors hit eject.

Good News First

Residential Real Estate has not had any major increase in debt-servicing in over 4 years.  Its cost the same to run a house today as it did in 2007/2008 peak.  Lower rates have made it possible. Looking at any measure that includes income is simply wrong (we don't know about off-shore mortgage, the cash buyer, bank of mom and dad, etc) 

1. The cost of running a home has moved up marginally since 2007, however still overvalued and a 10% drop on a much higher notional means a higher dollar loss, which is meaningful on a leveraged personal balance sheet. But with no margin call on homes, it won't be US style. It will have to arrive from folks losing jobs, rate shock, etc.


2. Rates are about 50bps lower since 2003

3. Looks shocking, but debt-servicing is the same as 2008.  Lower rates have allowed us to pay 20% more for homes

4. It takes about 1yr in lag to catch equilibrium levels from changes in interest rates

5. The CRE side is a different story, the graphs speak for themselves.  Cap Rates/Distributions to holders are almost at decade low levels, yet the prices have managed to stay at peak levels.  Interest rates have played the major role, however we are at the end-game. { 1. Low caps, 2. High Prices 3. Low Rates. } Not much flex here.  Do people really believe that they hold REITs with such high yields and have no risk?  Willful blindness are the best exit and shorting opportunities


2yr chart of XRE vs Cad Consumer, Energy and Canadian Financials

5yr chart of XRE vs Cad Consumer, Energy and Canadian Financials
BMO’s 2.99% 5-Year Fixed Sets Bank Record

Later today, BMO is reportedly announcing the lowest advertised 5-year fixed rate ever for a Canadian bank.
It’s a 2-week promotion at 2.99%. Official announcement to follow.

Manhattan Prices are the same on sqft since 2002

Housing Investment vs GDP, 2.5 year lag before correction.  Implied 2014

And when it does finally hit, it take a very very very long time to get the same you paid for it...

More Condos please


So how much does Housing impact Canada?

"With an average price topping $348,000 in January, Canadian homes are now worth a total of $3 trillion, nearly twice the country’s GDP. Home prices have doubled since 2002 and risen 13 per cent since the global recession hit in 2008.
When home prices rise, so does consumer confidence. Canadians, believing that their bricks and mortar are a gold mine, have become ever more willing to open their wallets. In less than 10 years, consumer spending has gone from 58 per cent of Canada’s GDP to 65 per cent.
The housing boom has helped prop up Canada’s construction industry, which now represents 7.4 per cent of the labour force, higher than it was in the U.S. at the height of its boom. Add in other housing-related industries, such as real estate agents, mortgage brokers and insurance companies, and the sector represents a staggering 27 per cent of the Canadian workforce. In the U.S., those same numbers peaked at 23.5 per cent.
More worrisome is where consumers have been getting their spending money. As wages stagnate and credit card use levels off, Canadian consumers have increasingly turned to their homes as a source of cash. As of last year, Canadians had pulled roughly $220 billion from their houses in revolving home equity lines of credit, a per capita amount three times larger than the U.S. at its peak.
Home equity lines of credit, known in the industry as HELOCs, have increased 170 per cent in the past decade, twice as fast as new mortgages. The federal government recognized just how risky HELOCs had become last April, when it announced it would no longer allow the Canada Mortgage and Housing Corporation to insure them.

But why should Global Bond Buyers care?  Everything is CMHC stamped.  The Banks actually want more mortgages to feed the demand....
"Since they were first introduced in Canada in 2007, such investments, known as covered bonds, have grown from a $2-billion industry to $50 billion, with much of the growth coming in just the last year. The rise in mortgage bonds has also worked to drive mortgage rates down by freeing up banks’ money to make more loans."

Purchasing Power running out of steam

"Mortgage rates are especially vulnerable. Shorter-term variable rates, which are linked to the Bank of Canada’s overnight rate, have become increasingly popular, now making up about 40 per cent of the market. Nearly half a million homeowners swapped their fixed-rate mortgage for variable rates last year. “If you’ve got a very big variable rate mortgage and those rates moved up two to three per cent, I think a lot of families are right at the line in terms of spending and suddenly they’re looking at a very big jump,” "

Good or bad, the banks want it off the books,

"Canada’s housing policy, including reining in the growth of mortgages insured by the CMHC. This month, the government-backed insurance corporation warned that it was close to maxing out its $600-billion budget for insurance, driven in large part by banks insuring portfolios of low-risk mortgages, which are repackaged as bonds and sold to investors, primarily in the U.S."



"As at 30 September 2011, the CMHC had only $11.5 billion CAD of shareholder capital but a whopping $541 billion CAD of outstanding insured loans, which works out at only 2.1% equity against its overall exposure. In fact, the CMHC’s capitalisation is only slightly better than the US Government-sponsored Fannie Mae, which in 2007, at the peak of the US housing bubble, backed up US$2.7 trillion of mortgage-backed securities with US$40 billion of capital, or 1.5% equity against its overall exposure."



"“The demand for large residences from 3,000 sq ft to 5,000 sq ft has been a real
surprise,” says Janice Fox, Four Seasons director of sales. “They all sold out within the
first year. We could easily sell another hundred more.”

Then the following a week, the sold out building suddenly has inventory and ads are placed

The Cube Indicator 

Dubai marked the top with a cube

Toronto Cube

and its back, BMO 2.99%.  The adverts can't keep up

Saturday, December 24, 2011

Our Jan SPY options double, Euro broken, money comes home, financial stress remains high and the hunt for yield has begun!

Our Jan SPY options double, Euro broken, money comes home, financial stress remains high and the hunt for yield has begun!

In our last post, we urged the need to buy Jan vol, our options have almost doubled in price with the surge in Santa taking the reins of the bull into the xmas close.  However, we feel the need for front month vol complemented with a short long dated vol (curve flattener) will perform beyond the current rally.

The market has broken the EUR.USD vs SPX to an extreme.  This was mentioned in our Euro Obituary post and now we see a even further dis-allocation after the ECB’s LTRO failed.  The market is not stupid, the ECB will need to print money and buy bonds in the open market in size and write them down on it’s balance sheet.  Currently, the banks are not willing to rent crash on their balance sheets no matter how attractive the carry trade is with huge leverage available.  With the banks getting the cheap funding and collateral swaps, they still need the free CDS (back stop of ECB) to take on this trade.  At the end if given, it’s the same as forward print of cash (prevent banks from large capital raises).  Otherwise they let the situation get worse, and print on demand.  You end up at the same spot, and the EUR.USD is reflecting this. This is reflective of a solution, rather then a shock.

1.  Nothing is fixed, money is still leaving EM and coming home to DM

2. Financial Stress continued to be high

3. The hunt for yield and risky duration has begun.  This bodes will for a vol flattener

4. SPY Jan 130 Calls and 134 Calls

Wednesday, December 21, 2011

Is vol oversold? We went from a 30 vol world to almost teens in two weeks? Start long averaging into upside vol now.

Is vol oversold?  We went from a 30 vol world to almost teens in two weeks (Index down 1%, VIX down 30%)? Start long averaging into upside vol now.

What sort of investing world are we living in?  In our last post, we made it clear that a rally would be violent and short lived if no real risk on trades were being put to work.  In fact, this rally has seen people nibbling a touch on risky duration, but nothing to explain the massive sell-off in vol and term structure shift.  We get the whole holiday thing, but what happens after?  From the below themes, we don’t see anything that makes us feel that the future environment will be rosy and vol will go to 15 (where you can buy upside baby calls right now)

Common Themes in the market

1) Santa Rally - BULL
2) Massive sell off in first quarter - BEAR
3) Second half of 2012, we are off to the races - BULL
4) ECB will just print and no one cares about the Italian 10y anymore - BULL
5) Everything is TBTF - BULL
6) Election year, Republicans will stall, toss economy downward to get Obama and his Volcker rule out- Election headlines will dominate as financials will rally with Mitt leadership as will Oil as US prepares for war with Iran - BULL/BEAR
7) “We don’t care what happens, we are happy getting our dividends from Utility stocks” - BLIND
8) Gold is cheap - BEAR
9) Short correlation, turn off computer, come back in Jan 2013 and turn on. - BULL
10) “Buy the dips” - RETAIL
11) “Do what feels wrong” - STUPID
12) China is a fraud and will implode - BEAR
13) Euro Fails, Defaults, we get the whale event that will end the circular reference - BEAR
14) PM’s are underweight, want to mark up stocks, need to buy - SAME AS 1, 10 and 11

1.  SPX Var Swaps 12M- 1M

We are at record steepness for the year.  We are going to play this by via cheap Jan VIX Iron Condors, buying SPY Jan 130 and 135 strikes for sticky vol play, selling 2 and 3year 1 by 2 put spreads.

2) 30’s to teens in two weeks?

3) VIX/GOLD/Market

Our vol buy signal is flashing at 6 to start entering.

4) The best for last

Index is down 1%, VIX is down 30%?

Thursday, December 15, 2011

When the fear of missing a rally is greater then the fear of losing money. DO NOTHING

When the fear of missing a rally is greater then the fear of losing money.  DO NOTHING

With the market this year making so many firsts, it never seems to end. After our Nov 29th risk off extreme post, the EUR.SPX correlation died after the swap lines were released. Gold, China and commodities got clobbered and correlation stayed very high for the index.  And out of all this global movement, SPX is in our year-end range of 1175/1225.  

PFG believes that volatility is being artificially suppressed due to the sudden need to be in anything USD$.  Money is moving back into DM from EM in the face of global risk de-leverging, that in turn is keeping USD$ assets bid creating the illusion all is well in the US and volatility is collapsing in the front, however it’s not in the back.  Infact, its almost at the year highs!

Our indicators again show us that re-risking rally could be very powerful, however if don’t see a bid into risky duration, it will be short lived.  With the SPX in our range, and not getting paid to take any significant risk, we are doing nothing.

1) We posted on Nov 29th that risk off was too extreme.  In addition, after the our euro obituary post, the eur correlation died.  This now leaves the market in our year-end range and volatility has totally collapsed in the front of the curve.  However....

2. ... money continues to de-risk out of EM and back into DM (explains the USD global bid)

2. Financials showing again up at oversold levels.  They can easily move up 5-7% in a re-risking rally.

3.  No faith in risky long duration continues.  This coincides with the steep vol curve.

the vol curve today is vs {min, max} for the year in the mid in the front half, however the long end is still very close to year highs!

4. Long/Short - same story, high correlation.  Hedge Fund returns stagnant
5. Vol using GLD and SPY seems rich and a rally could take VIX to 25 very very fast if a rally starts, however it is already cheap to current spot and we don’t expect this outcome.
(from last post, same comment, and vix is lower, graph updated)