Monday, October 17, 2011

Risk off time.....

"Made in Germany, you know the German's always make good stuff". The poignant observation from Shamwow! advertising icon Vince (http://www.youtube.com/watch?v=dYvP_bCnS2I) sadly will not apply to a comprehensive EU bailout plan.... at least not yet. I mentioned in my first post that I thought getting short before October 23rd, the day we were slated to hear about some fantastic European solution, was too risky despite the  technical resistance levels we were encroaching on.  So now the picture has changed. The markets sell off today following Germany's finance minister warning that October 23rd would not be the day of the grand unveiling of how Europe would be saved. In doing so, Germany has signaled to the markets that short term risk to the upside is off the table. So now, the basis of my "its not worth shorting this market" concept is gone, and I'm having trouble finding any reason to get long. Katie Stockton, who seems to be right a lot more than she is wrong, put the next support level for the S&P at 1100. That's an 8% drop from here. Sure doesn't make this look like much of a buying opportunity.

Gold had an interesting start to the day, trading higher pre-stock market open when the stock futures were clearly indicating a lower open. As stocks began to sell off so eventually did gold, but the shiny metal did show some resilience. Trading now at 1674, we are less than 10 dollars below Friday's settle. It will be interesting to monitor this gold/ equities relationship, to see if maybe gold's faint glimmer of strength could mark the start of a decoupling of their strong correlation. The options however are not showing any break just yet. Gold puts continue to get bid relative to calls (equivalent delta put options are trading at higher implied volatilities than calls.... ie people are starting to pay up more for puts more than calls). In equity markets, there is a skew to puts (puts are relatively more expensive than calls) because of the disproportionately large demand long investors have for the protection puts provide against a downturn. While I can't speak with too much knowledge about equity options, as fear of the downside increases, so does the volatility (the amount people will pay for options).  Currently in gold we are seeing puts get bid, and volatility which came off hard last week, started to catch a bid as well. This indicates to me that people continue to see room to the downside in gold....today the VIX (volatility index on the stock market) spiked (fear of downside)... add it up? Options in gold seem to be following options in equities...so the correlation lives on.

I wouldn't harp on the options piece as much, if it weren't for what happened last time gold topped out. It was the second time we were trading above 1900 (having sold off and rallied back up) and suddenly the gold options completely changed pattern. For the entire move up, call skew was going out (people were paying up for calls). Then one day, while we were trading higher, the puts started getting bid. This was a break in the pattern. That day just happened to be the day before gold made its high. So perhaps it is a bit of a leap to liken the implications of the skew move at gold's last top to the current gold/equity relationship. But for the time being, it is worth monitoring the change in the way the options for the two behave, as it can serve as a very valuable leading indicator.

I am still not satisfied with any of the explanations I've heard about the accounting provision that allows banks like JPM and C to goose their bottom line because of the cost of debt. Sans Bloomberg machine I am struggling to get some of the answers I want, but will continue looking into it because I think there might be some interesting takeaways. If anyone has information on the matter, please feel free to share.

I'm off to watch the Jets try to salvage their season. A loss to the Dolphins could certainly lead to an onset of depression, causing me to miss a day or two of posting. If this happens, I hope that my loyal and broad following will accept this as a preemptive apology.
-Ben

No comments:

Post a Comment