Risky business

Macro Man doesn't often delve into single-name space, because the due diligence required to make an informed investment is decidedly more micro than macro, and he simply does not find it particularly interesting.  Still, he can appreciate a nice salacious scandal as much as the next chap, particularly in a name that enjoys wide (or at least noisy) ownership.  Yesterday's report that sent Valeant tumbling wasn't exactly a deep dive into the minutiae of the company's business model and financials, but still managed to ask a couple of decidedly uncomfortable questions that point to some sort of fraud.  And oh! the irony!  One of Valeant's largest shareholders (who apparently went on the telly yesterday to trumpet additional purchases) is the same bloke who's always claiming Herbalife is a fraud.  Remember, kids: becoming a distributor so you can buy fat-kid shakes at a discount is fraud, but secretly owning a chain of dodgy pharmacies that buy your products but don't pay is just good clean fun!

Anyhow, Macro Man and a friend were chatting yesterday about option skew and various indices to measure it.  His mate pointed out something called the Credit Suisse Fear Barometer (any reference implied by that acronym is strictly Freudian, we are assured), which purportedly calculates the put strike that you can buy for zero cost in return for selling a 3 month 10% out of the money call.  The greater the distance from spot (i.e., the higher the index), the greater the fear.  It seemed simple enough until your author pulled up a chart, and saw that the index moved in lockstep with the SPX over the last couple of months...but not in the way you'd expect.  Clearly something is amiss with the calculation of the index.


This got Macro Man thinking....why not just look at good old fashioned risk reversals (i.e., the buy/sell of a call/put of identical deltas) and see what they say?  So he punched up the data on his trusty Bloomberg, and while it can be a little sloppy, here's what he got:


That makes a bit more sense....a sharp increase in the demand for puts a couple of months ago, which has generally receded as conditions have settled.   Note that the bid for puts is still above the generally prevailing levels of the past few years, however.  Perhaps it's a reflection of prior positioning, but puts never went quite so psycho bid in Eurostoxx....


China is a really interesting chart.   Using FXI as a proxy, we can see that at the height of the equity rally bubble this summer, riskies were actually bid for calls!   Uh....that was a bad idea, and when it reversed, it reversed hard.  Interestingly, however, the bid for puts has receded tremendously in the last few weeks.  A sign of complacency, or that hot money's gotten out?


There'd appear to be little opportunity for complacency in Brazil, where the Bovespa is the 4th worst performer globally (and Macro Man's ashamed to admit that he had to look up the location of one of the lower three!)  One would normally expect such execrable performance to be met with a massive demand for puts, but according to the Bloomberg data, it hasn't really materialized.   Some of this may reflect the fact that weak hands have gotten out; shares outstanding of the ETF are less half of what they were three years ago.   Then again, the level of out-of-the-money implied vols are quite high on an absolute basis, perhaps dissuading purchasers of naked options.

Finally, what of IBB?  Unsurprisingly, biotech puts remain relatively well bid compared to broader country indices, reflecting both the shoddy performance of the underlying and (perhaps more importantly), the relatively heavy positioning in the industry.  Indeed, shares outstanding of IBB reached an all time high at the end of September.

Summing up, what do we find?

Most of the risk reversals surveyed are at or slightly above longer-term averages, reflecting neither complacency no panic at the present juncture.  The exceptions are biotechs, where puts remain very well bid, and China...where they don't.   Obviously the horse has already bolted in Shanghai equities, but between the low level of the FXI risky and the apparent bottoming of USD/CNH, it doesn't look like a bad time to slap on hedges for China tail risk if you are so inclined.

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Polemic
admin
October 22, 2015 at 7:40 AM ×

Would I be correct in surmising that the riskies just track underlying vol in general? The spx riskies look just like vix. Makes sense as stressy times sees vol rise as cover sought and that cover is nearly always puts against cash holdings. Your commentary re where we sit in the riskie charts is exactly that of vol /vix.

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Hoboworldwide
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October 22, 2015 at 7:49 AM ×

MM you have to be very careful at making macro comparisons across markets based on skew as flow has a massive impact. Auto callable structures sold in Asia dominate at the moment but the index of choice for these are generally SX5E NKY and KOSPI / H Share. SPX doesn't make the structure look good to sell to retail. They are also often structure on a worst of basis and because of the barrier this cause bank positioning in Vega to move dramatically with spot.

As always a little knowledge is a dangerous thing and I can only scratch the surface here of the dynamics in the implied volatility market.

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abee crombie
admin
October 22, 2015 at 1:50 PM ×

Interesting insights MM, and thanks for the comments. How did you pull up those figures from the Bloomy MM?

I know risk reversals are used commonly with FX, but I am not that familiar with them. Anyone care to expands on when and what they are good for.

On Ackman, he's the mad scientist of the HF land. Some of his moves like HLF and VRX you scratch your head, but then on others like Allergan (which was why he started VRX) CP or General Growth he did some outstanding work that really blew ppl away. Remember this is the same guy who pounded the table on Ambac or MGIC for 2 years before ppl caught on. He does a lot more work than I do on single names, so I give him the benefit of the doubt

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Macro Man
admin
October 22, 2015 at 2:49 PM ×

@Abee, the BBG function is GV. They are kind of an analog to the put/call ratio, except instead of looking at trading volume of puts and calls, you are looking at trading impact/market pricing of those puts and calls.

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theta
admin
October 22, 2015 at 3:53 PM ×

@hobo, these dynamics you mention affect long term vol, I believe MM's charts are for 3 month skew.

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CV
admin
October 22, 2015 at 5:26 PM ×

The only real question we need to answer is; how long can Mr. Draghi continue to do this? My base case is that they will cut the dep rate AND expand QE in December, but then what. They are setting themselves up for a u-turn next year, but for now ... it is happy, clappy days.

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Anonymous
admin
October 22, 2015 at 5:33 PM ×

Draghi promises endless QE and NIRP.
BOJ have just announced NIRP.

Dax is up +400 points on the day. USDJPY has endless bid courtesy of BOJ.

How are the equity shorts here doing? Margin liquidation time yet?

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Mr. T
admin
October 22, 2015 at 7:06 PM ×

Well at least the central bankers are finally dovish.

I've got 7 of 10 EMEA with negative rates on the 2 year now (only UK, Portugal and Greece positive). Portugal @ 21bp! This is a series that yielded well over 15% a couple years ago. So lets not underestimate the power of the cb's and their willingness to plow ahead with policy. But seriously, what next? I for one don't think that increasingly negative depo rates are going to increase M2 turnover or inflation. I'm really scratching my head at what the long run plan is - lets take this to the "most dovish" conclusion something crazy like dec meeting puts depo at -500bp and QE until 2020. We know this will make assets go up on a relative-yield basis, but how is this supposed to create any real economic change or growth? The whole thing seems backwards.


I think this rally is bogus and while I'm trying to remain constructive and bullish into EOY the idea of policymakers exploring the limits of whats possible does not make me want to put on more risk.

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washedup
admin
October 22, 2015 at 7:18 PM ×

"How are the equity shorts here doing? Margin liquidation time yet?"

This statement as a timing indicator

-Beats %R
-Beats RSI
-Beats P/E multiples
-Beats a voluntary defenestration by yellen, kuroda, and draghi, from the eccles building.

Time to lay your bets.

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Anonymous
admin
October 22, 2015 at 9:04 PM ×

Sorry washed, you might wanna just check the earnings releases... Nasdaq up +200 ticks on the release. Equity longs win (again).

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abee crombie
admin
October 22, 2015 at 9:11 PM ×

Internet earnings to the rescue...S&P 200 moving average right here ... nasser comfortably above now... I will take a stab short, but who knows

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Anonymous
admin
October 22, 2015 at 9:28 PM ×

Raise rates!

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washedup
admin
October 22, 2015 at 9:28 PM ×

anon - no need to be sorry - my point was simply that cockiness by the winning team is a powerful force - feel free to peruse the bears' posts when we were down at 1890.
I am happy to stop out if this rally gets out of hand of course - but I think risk/reward is improving to the downside.

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Mr. T
admin
October 22, 2015 at 9:49 PM ×

FOMC gonna be eyeballing the DXY next week. What a system. I love the strong results from the NDX names, and these are not the 'buyback to hit EPS' names but the 'were gonna destroy the competition' names. It's a shame I don't own any of those names beyond index exposure, I don't understand why the stocks trade where they do, but it gives me greater confidence that the economy is rotating, not falling apart.

SPX negative for the year still, NDX just 'crowning into positive territory. Not much to crow about on either side if you ask me.

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Anonymous
admin
October 23, 2015 at 7:01 AM ×

Hoboworldwide hit the nail on the head there. Asian autocalls have sent the SX5E loco last 18months and on a fixed strike basis spot higher now equals vol and skew higher in contrast to options101.

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Sets Shaibu
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