Monthly Archives: September 2020

is the options-driven selloff over?

September 11, 2020 By in Strategy, Uncategorized Tags: , Leave a comment

My guess is that it is.

what happened

Let’s say you buy an exchange-traded call option (which is the usual kind) on XYZ stock through your discount brokerage account. This means you’re entering into a contract, typically with a big brokerage house on the other side, that gives you the right–but not the obligation–to buy (typically 100 shares of) XYZ at a specified price at any point over, say, the next three months. You pay a premium that’s basically a function of the length of time the contract is in force.

The Options Clearing Corporation Corporation makes sure that both sides have the wherewithal to fulfill their side of the bargain–in this case, that the brokerage house is able to deliver the shares if you exercise the option.

The brokerage house typically hedges its exposure by buying either XYZ shares or options or some other derivative instrument but typically not at 100%. Maybe 30% instead. As/if the price of XYZ begins to rise as new options buyers emerge, the broker not only hedges the new exposure but also boosts the percentage coverage to, say, 50%.

If the first option purchase triggered buying 30 shares of XYZ as a hedge, the second triggers buying of 70. If the stock price continues to rise, new options purchases cause the broker to buy increasingly large amounts of the underlying stock. At the same time, the pool of willing sellers of the stock begins to dry up. If this process continues, the result is a melt-up in the stock price of XYZ.

why I think it’s over

Brokers have learned that failure to follow their coverage rules immediately–on the idea that tomorrow will bring a better opportunity than today–is a recipe for disaster. So, like it or not, they act right away.

Once brokers are 100% hedged, the pressure to buy more abates.

Certainly Softbank, if not other option buyers as well, are aware of this phenomenon. Softbank may well have none its gigantic options buy with the intention of forcing, and profiting from, the meltup that happened.

Softbank quickly learned that its shareholders don’t want the company to have stock market speculation as its main moneymaker. For their part, I imagine brokers will be more fully hedged with new options contracts for a while at least, making a new meltup less likely.

what to do now

After dramatic market moves, it’s always good to reassess portfolio structure to see what went well and what didn’t–and fix problems you may find.

Looking for the stocks that are recovering strongly vs. ones that are lagging behind or still falling will give us clues to where the market may be moving next.

parts of an email from yesterday

September 9, 2020 By in Basic Concepts, Constructing a Portfolio, economics, stock market, Strategy Tags: , , Leave a comment

I guess you’ve seen all the stuff about huge buying of options on individual tech stocks, both by Bar Stool-style traders and by Softbank, driving tech stocks up.  My guess is that has ended for now.  If so, it will probably take a week or so for trading in the big tech names to settle down.

I’ve read that when the Tokyo market found out what Son had been up to, and had made $4 billion on speculative options trading, Softbank dropped by 8% (?), losing shareholders $20 billion in market value.  That’s because what he did is bet-the-company crazy.

One of the things I’ve noticed is that some second-line names are doing much better (meaning falling more slowly) than what must be Robinhood-ish favorites.


It’s never clear what triggers a market selloff.  In this case, though, it’s doing a healthy thing by readjusting relative values among different groups of stocks–something I’ve thought would happen by a temporary reversal of leadership in an uptrend.

I think the fact that at zero interest rates stocks are the only game in town means stocks will drop to some longer-term trend line, stabilize, and then begin to move up again.  A hope, not a belief–at the close today NASDAQ seems to have hit the bottom of a channel it’s been in since April.  (It’s also about 25% above its March high, which says these are not bargain-basement levels.)


Over the past 5 trading days, NASDAQ is down by -9.2%, the S&P by -5.5%, and the Russell by -4.7%, so there is outperformance of a sort by the R2000.
Very often after a big selloff, market leadership changes.  That didn’t really happen in March, although afterwards the R2000 began to keep up more with the S&P for several months.  My sense is that the market wants to broaden out to find non-tech stocks that will do well over the next year or two.  This is why consumer discretionary names have been doing well recently.  But because some kinds of tech are going to be long-term winners, the move has to be based on finding consumer names that have good growth prospects, not just that they’re in another sector. 

The market hasn’t gotten conviction yet with this idea, probably in large part because Trumponomics gets loonier by the day.  The near-term economic outlook in the US had already been deteriorating before his latest China ideas, and won’t have a chance to be better unless he’s defeated in November.

Then there’s the human side of things. Who’d have thought we’d see George Wallace reincarnated, or the Waffen SS recreated, or scary abuse of power in the Justice Department–or that the Joint Chiefs would feel the need to say they would not obey any Trump orders to use troops to deny Americans their civil rights.

 
The last two paragraphs both bear on stocks like NWL.  Arguably, NWL is a true “value” name.  That is, all the bad stuff–and more–that could reasonably be expected to happen has already taken place and been factored into the stock price.  So it has some downside protection. It’s also economically sensitive and non-tech; and maybe if management can use the company’s assets competently, good things will happen. 

Another way of putting this is that in a world where TSLA can be down 30% in a week maybe the value formula of dead money for now with the hope of upside later on isn’t so bad to have as part of a portfolio.

Warren Buffett and the Japanese sogo shosha

September 2, 2020 By in Asian economic development, economics Tags: , , Leave a comment

Yesterday, Warren Buffett announced that one of his insurance companies, National Indemnity, has acquired 5%+ positions in each of the five largest general trading companies (sogo shosha) in Japan. The yen currency asset exposure this creates is reportedly hedged through National Indemnity’s ownership of yen-denominated liabilities.

Buffett has given no rationale that I’ve seen for his purchase, although press reports point to stock prices at 75% of book value.

As it turns out, I spent a lot of time studying the Japanese trading companies at one point in my working career. I was a significant shareholder in Mitusbishi Corp. for a couple of years, and got to know that company quite well.

The general trading companies grew in importance to the Japanese economy after WWII as the country became a growing exporter of all sorts of goods. Each of the large industrial conglomerates (zaibatsu/keiretsu)–Mitsubishi, Mitsui, Sumitomo…–consolidated all its dealings with foreign countries, especially trade finance, in a single entity, its in-house trading company. Given that Japan is a natural resource-poor country, lacking energy resources in particular, the keiretsu were tasked by Tokyo with arranging for steady energy supplies. This task fell to the sogo shosha, as well.

The obvious investment attraction of the sogo shosha is that they’re cheap. On the other hand, they tend to remain cheap, for several reasons:

–the trading companies are embedded in the old samurai-era conglomerate structure. This is the most rigidly hierarchical, stuck in the mud part of the Japanese economy. They are tightly bound to the conglomerate whose name they bear and a re not free to make the economically best decisions for themselves

–they tend to have hundreds of subsidiaries, without any apparent desire to rationalize their structure

–they’re basically finance companies, which tend to trade at low multiples

–in the energy area, they act as national champions, not necessarily as profit-maximizing entities for themselves.

It will be interesting to see whether in this case Buffett is much more deeply knowledgeable about these Japanese firms than I am or whether this is another case of beefing up tech exposure by buying IBM because it looks cheap.