Be careful when flying to the Moon
30 Jan 2021 - Thomas Poh
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Much has been published on the war between retail investors taking on hedge funds who are short stocks like GameStop and AMC. Speculators serve a function of facilitating price discovery, both long and short alike. Though the process, is seldom smooth (if ever), they are still a vital part of the market. Speculators take a position when the perceived rewards outweigh the calculated risks involved. Shorting a stock is inherent risky because of the unlimited loss that could be incurred as compared to a long position which is restricted to the notional value invested in the purchase. The short squeeze sparked by retail traders’ long call positions is simply forcing the shorts to re-assess these risk matrices.
Morality and political affiliations aside, this is the brutal laws of the financial market’s jungle functioning the way they are designed to be. Markets will always tend to squeeze crowded trades regardless of the direction. With 140% of outstanding free float being shorted, GameStop was a crowded short trade waiting to be squeezed. This is not the first time this has happened. Back in 2008 Volkswagen (VW) stock quadrupled and spiked to EUR1000 after Porsche announced an audacious takeover. But the real driver then was that the market quickly realised that the short positions is more than the total free float of the VW stock available in the market.(Shorting auto stocks were used as a proxy to short the market during the Lehman crisis as regulators banned the shorting of financial stocks) |
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It is safe to say that most (if not all) the buyers of GameStop and all the related short squeeze trades are speculative in nature. Therefore, a strong word of caution to all the newly empowered retail traders, there are risks to this trading strategy even if it is executed via options.
Firstly, although the long call positions limit the downside to just the premium paid, most of the call positions are also leveraged. The online broking houses are the ones funding these call positions for a nominal amount of initial margin paid upfront by the retail trader. The cost of this funding will most likely be increased or the leverage can be totally removed as the market volatility (and risks) increased exponentially. We are already seeing this happening.
Secondly, this is no longer a cheap punt unless one has entered at the very early stage. The spike in both the underlying stock price and volatility have made the premiums cost of such calls daunting. As the point of writing this article, a 1-week at-the-money call option on GameStop trades at nearly 50% of the underlying share price! (share price = 312, 1wk call option with strike at 312.5, the premium = $128). Long options face a negative time decay. i.e. you lose money every day as the option gets to expiry, ceteris paribus. Hence, you will lose all your premium if the options expire out-of-the money.
Lastly, in any trade strategy, there must be an exit plan. One obvious way to exit is to sell (either the call itself or exercise the call, assuming it is in-the-money, and sell the underlying stock) when the shorts are desperately covering. However, that short covering will eventually subside. At that point, the stock’s fundamentals will start to kick in. While everyone is calling for the stock to go to the moon, for those that had been there, they will be quick to tell you that the moon is pretty much an empty place. The price of one tulip bulb is equivalent to the price of a Renaissance painting at its peak during the tulip bubble. Such a trading strategy requires the “next better fool” to take over your position. The market price and liquidity might not be there for you to close your position.
A bubble is a bubble no matter how you like to call it. Every generation needs to learn their own lesson in terms of bubbles. From tulips to dot com to the housing bubble in 2008. Nothing has changed because we humans as a species have not. The fundamental greed and fear emotions are part of our biological setup. As a particular generation learns its own lesson and get wiser, the next generation will need to re-learn the same lessons. This is simply because such wisdom cannot be truly gained by reading history books and a change of the context will always make people believe that "this time it’s different". True experience can only be gained by going through it yourself. These are also the reasons why history keep repeating itself and bubbles will always be reappearing. Hence, enjoy the ride but do not be Johnny come late and be the last one holding the hot potato.
Firstly, although the long call positions limit the downside to just the premium paid, most of the call positions are also leveraged. The online broking houses are the ones funding these call positions for a nominal amount of initial margin paid upfront by the retail trader. The cost of this funding will most likely be increased or the leverage can be totally removed as the market volatility (and risks) increased exponentially. We are already seeing this happening.
Secondly, this is no longer a cheap punt unless one has entered at the very early stage. The spike in both the underlying stock price and volatility have made the premiums cost of such calls daunting. As the point of writing this article, a 1-week at-the-money call option on GameStop trades at nearly 50% of the underlying share price! (share price = 312, 1wk call option with strike at 312.5, the premium = $128). Long options face a negative time decay. i.e. you lose money every day as the option gets to expiry, ceteris paribus. Hence, you will lose all your premium if the options expire out-of-the money.
Lastly, in any trade strategy, there must be an exit plan. One obvious way to exit is to sell (either the call itself or exercise the call, assuming it is in-the-money, and sell the underlying stock) when the shorts are desperately covering. However, that short covering will eventually subside. At that point, the stock’s fundamentals will start to kick in. While everyone is calling for the stock to go to the moon, for those that had been there, they will be quick to tell you that the moon is pretty much an empty place. The price of one tulip bulb is equivalent to the price of a Renaissance painting at its peak during the tulip bubble. Such a trading strategy requires the “next better fool” to take over your position. The market price and liquidity might not be there for you to close your position.
A bubble is a bubble no matter how you like to call it. Every generation needs to learn their own lesson in terms of bubbles. From tulips to dot com to the housing bubble in 2008. Nothing has changed because we humans as a species have not. The fundamental greed and fear emotions are part of our biological setup. As a particular generation learns its own lesson and get wiser, the next generation will need to re-learn the same lessons. This is simply because such wisdom cannot be truly gained by reading history books and a change of the context will always make people believe that "this time it’s different". True experience can only be gained by going through it yourself. These are also the reasons why history keep repeating itself and bubbles will always be reappearing. Hence, enjoy the ride but do not be Johnny come late and be the last one holding the hot potato.
FX Options: An Alternative Way to Trade FX for Retail and Financial Institutions
(published on CME Group's website)
15 Sep 2020 - Thomas Poh
It has been over six months since the COVID-19 pandemic hit the global economy and sent financial markets into one of the wildest rides ever seen. Extreme market volatility was seen across all markets with unprecedented markets dislocations. With the Fed’s intervention, by announcing QE Infinity in March, financial markets has since embarked on a dramatic turnaround. Gold and Nasdaq both hit all-time highs, while yields dropped to rock bottom. The FX market also went on a roller coaster ride. The DXY Dollar-index made a big reversal since its near 9% spike in March mainly driven the Fed’s relief measures, the eurozone’s agreement to a EUR 750 billion pandemic fund, and the escalation of the COVID-19 spread in the US
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Click on the links below to read the full article
https://www.cmegroup.com/education/articles-and-reports/fx-options-an-alternative-way-to-trade-fx.html
https://www.cmegroup.com/education/articles-and-reports/navigating-the-choppy-markets-with-fx-options-a-retail-traders-perspective-on-fx-trading.html
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Click on the links below to read the full article
https://www.cmegroup.com/education/articles-and-reports/fx-options-an-alternative-way-to-trade-fx.html
https://www.cmegroup.com/education/articles-and-reports/navigating-the-choppy-markets-with-fx-options-a-retail-traders-perspective-on-fx-trading.html
Fed’s Road to QE Infinity and Beyond (published on CME Group's website)
17 Apr 2020 - Thomas Poh
The COVID-19 outbreak has hit the world like a hurricane. The ongoing medical and humanitarian crisis has also sparked off an economic and financial one. As the world realised that the virus knows no borders, global financial markets tanked. The longest stock market bull run in history ended in the most dramatic fashion as the S&P 500 lost as much as 34%, at its lowest point, on 23rd March.
As countries go into lockdown and the stock market went through a tsunami-styled selloff, secondary tremors were immediately felt across all other asset classes. These asset markets went through huge (some unprecedented) market dislocations, driven by one major common theme, FUNDING. Leading bond ETFs were trading at deep discounts against their NAVs and the USD index rose by almost 9%. The three-month Libor jumped 16bps on 17th March 2020 while the price of Jun 2020 futures indicated Libor vs SOFR spread to be as high as 57 bps at maturity. At one stage, the market even started to sell treasuries and gold simply to raise cash, ignoring their usual flight to safe-haven assets.
Click on the link below to read the full article
https://www.cmegroup.com/education/articles-and-reports/feds-road-to-qe-infinity-and-beyond.html
As countries go into lockdown and the stock market went through a tsunami-styled selloff, secondary tremors were immediately felt across all other asset classes. These asset markets went through huge (some unprecedented) market dislocations, driven by one major common theme, FUNDING. Leading bond ETFs were trading at deep discounts against their NAVs and the USD index rose by almost 9%. The three-month Libor jumped 16bps on 17th March 2020 while the price of Jun 2020 futures indicated Libor vs SOFR spread to be as high as 57 bps at maturity. At one stage, the market even started to sell treasuries and gold simply to raise cash, ignoring their usual flight to safe-haven assets.
Click on the link below to read the full article
https://www.cmegroup.com/education/articles-and-reports/feds-road-to-qe-infinity-and-beyond.html
Market Update - Is the bull market resurrected?14 Apr 2020 - Thomas Pohn the 24 Mar 2020, we published a market update titled: “Signs of Market Consolidation – 4 Interesting Charts” calling for the market to have found a potential base after the relentless selloff starting in the early part of March. The announcement of the Federal Reserve’s decision to embark on Unlimited Quantitative Easing, a.k.a “QE Infinity” as well as a host of other measures, like the provision of USD swaps credit lines to foreign central banks, seemed to have restored stability in the funding markets.
The market’s reaction since then was arguably just as fierce on the rebound. The S&P 500 index futures hit a high of 2818 on the 13th of April vs the low of 2174 registered on the 23rd of March. This is represents a 30% jump from the low. Technically, an increase of more than 20% from the previous low represents the start of a new bull market. However, as we had anticipated for the selloff to abate on the 24th of March, we would also now advise caution against over-optimism... ... Click on the link below to read the full article 
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Critical Trading Strategy Components – Part 2b13 Apr 2020 - Thomas PohIn previous session, we have covered the importance of recognising the time horizon which we plan our trade strategy. Defining our trading time horizon allows us to have the right time perspective when we assess the changes in the market vis-à-vis our strategy. It also helps us maintain discipline and prevent us over staying in our positions. In this second part of “Trading Time Horizons”, we shall touch on how it affects the other aspects of our trading.
Firstly, our time horizon affects how we calibrate our market analytical tools. ... ... Click on the link below to read the full article
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Driving the glittering gold trade
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| gold_rally_7_apr_2020_cn.pdf |
Critical Trading Strategy Components – Part 2a6 Apr 2020 - Thomas PohWe have covered the importance of selecting the correct product to express our market view in our 2 previous sessions. Picking the wrong product is comparable to choosing the wrong tool for the task. The next component to be discussed is one that is VERY personal to the individual trader. It varies across traders and yet it seems to be the least discussed or mentioned when traders exchange their views or trading strategies. It is not an exaggeration to state that most traders do not even see this as a critical component of any trading strategy. This component is that of “Time Horizon”.
A trading strategy’s time horizon defines the time perspective in which we start building our market view. It would also set the timing of which we would expect the various scenarios, which we have envisioned, to pan out... ... Click on the link below to read the full article
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Critical Trading Strategy Components – Part 1b30 Mar 2020 - Thomas PohLast week I had highlighted to everyone that there is a lot more to a winning trading strategy than just determining the direction of the trade (click here for link to Part 1a). The relative performances between SHCOMP and HSCEI from 2014-2016 were used to illustrate how the underlying product chosen can determine the outcome of the trade strategy. In this follow up section on Product, I will illustrate that there is also more than one way to go long (or short) on a stock.
The most obvious way to express one’s bullish view on a stock is to buy it. This is what we called a physical or cash trade. However, depending on the circumstances, this may not always be the best way to express one’s bullish view. Again, the choice of the Product is important here. So what are the other ways to have a long position? Using the purchase of S&P index ETF to go long the S&P index as an example, I will illustrate are 3 other ways to be go long S&P index besides buying the ETF. Click on the link below to read the full article
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“Critical Trading Strategy Components”- Part 1
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26 Mar 2020 - Thomas Poh |
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A lot of us talk about our market views and trading strategies but not many of us take a systematic approach towards planning and executing one. Let’s ask ourselves, how many times did we have the correct assessment of the market but yet came out short? What happened? I mean, we had the right view to begin with. Shouldn’t that should be half the battle won? Why did we end up not making or even losing money? A fellow trader once shared with me this saying, “The saddest thing that can happen in trading is to have the right view but yet lose money”. Wise words indeed. So what went wrong?
The answer is simply this. Having the right call of the market direction is nothing but the first step in forming the winning trading strategy. In fact, there are a few more components that form the trading strategy that are actually more critical than direction. It is arguable that one would even conclude that Direction is the least difficult component to decide because it is ultimately a digital decision. It is either up or down. |
In this series of “Critical Trading Strategy Components”, I shall share with you what the other components of a winning trade strategy are. We shall begin with “Product”.
Click on the link below to read the full article
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Signs of Market Consolidation - 4 Interesting Charts
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24Mar2020 - Thomas Poh |
The funding markets seem to have found a temporary footing as central banks attempted to counter the outbreak with their own shock and awe bazookas. The ECB unveiled an EUR 750bio bond purchase 5 days ago while the Fed announced unlimited quantitative easing yesterday as their latest salvo. The US Congress is also debating an up-sized USD2 trillion stimulus package.
On the medical front, although the confirmed cases reported globally continue to rise together with the death toll, we have good news out of China where there is an announcement in the relaxation of the travel restrictions imposed on Wuhan.
All these sparked a rally in equities led by US equities futures which is currently up 5% in both the S&P 500 and Nasdaq at the time of this report writing. While it is unlikely that the bear trend in equities will end, given that the economic impact of this outbreak potentially overshadow that of the Global Financial Crisis, there are signs of the market reaching a temporary consolidation phase.
Below are 4 charts that might be interesting.
On the medical front, although the confirmed cases reported globally continue to rise together with the death toll, we have good news out of China where there is an announcement in the relaxation of the travel restrictions imposed on Wuhan.
All these sparked a rally in equities led by US equities futures which is currently up 5% in both the S&P 500 and Nasdaq at the time of this report writing. While it is unlikely that the bear trend in equities will end, given that the economic impact of this outbreak potentially overshadow that of the Global Financial Crisis, there are signs of the market reaching a temporary consolidation phase.
Below are 4 charts that might be interesting.
1) The US Treasuries (UST) finally reversed their selloff and rallied over the last 2 days (treasuries prices have an inverse relationship with yields). This a sign that the Fed's QE measure is restoring some calm in the market which saw heavy selling of Treasuries to raise cash. As we recall in my previous report, UST temporarily of its traditional flight to quality correlationship with equities during last 2 weeks' violent asset selloff because everyone was just selling everything to raise funding.
2) The stock market has lost ALL of the post-Trump election gains. We are hovering at the point of breakout of the Trump rally which started in 2016 which in turn forms a natural support. More interestly, if we zoom into the chart over the last 2 days... ...
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3) Doji stick technical indicator sighted yesterday. This is a sign of market INDECISION. Although this does not necessary signal a reversal, it does indicator that the market is struggling to make new lows in the recent selling trend.
4) Divergence between S&P and VIX. The equities volatility index VIX also known as the "fear index" is reversing in spite of the continued selloff in equities over the last few days. Usually VIX climbs higher as volatility increases during equities selloffs. The fact that there is a divergence shows signs of market exhaustion for shorts.
Click on the link below to read the full market report
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Bottom line: The bear trend in equities is still intact but there is risk that the market will go through a consolidation phase soon. Time to lock in some profits for short positions.
Indicator of the End of Market Panic - The Gold correlation
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source : CME Group
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Fight the Fear
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| pzh_covid_mkt_update_18mar2020.pdf |
source : Financial Times
Source : TD Ameritrade - ThinkorSwim
SOFR & Overnight Repo Spike18Sep2019 - Thomas PohThe recent spike in USD overnight repo rates is widely attributed to US corporate tax payment activities as well as the reduction in the Fed balance sheet which resulted in subsequent reduction in US banks cash reserves. As result, the Fed had to inject USD 75bio into the overnight market more than once in order to ease the squeeze. This event cast new light on the significance of the Secured Overnight Funding benchmark (SOFR) and SOFR Futures which was adopted in 2017 as the alternative to the now infamous LIBOR,. Fed Fund futures (and on the same note USD OIS) has been proven to be ineffective in its use as an hedge against USD overnight funding risks. SOFR, which is calculated based on transactions derived from the very same squeezed repo market, is a direct measurement of this funding risk. As such, CME SOFR futures and SOFR OIS are a more natural hedge against actual repo funding risk. Similarly, SOFR vs Fed Futures spread will be a key barometer of funding conditions going forward |
source :bloomberg
source : bloomberg
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My ACTA Journey
12 Jul 2019 - Thomas Poh
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CHICAGO! That is the code word for any Learner who has successfully achieved COMPETENCY which is what most of us would call a "Pass" for the Advance Certificate for Training and Assessment (ACTA). (For those that need to know, the alternate scenario is Not Yet Competent... ... )
Yes, it has been quite a journey for me since the day I had decided to sign up for ACTA. As an already practicing trainer, I admit that I had pre-conceived notions and much reservations of what to expect. How is this course going to help me? Am I re-learning what I already know? As it turns out, like all new experiences, it was definitiely an eye-opener and - in every sense of the word - a learning experience to remember ! |
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