What We're Reading ~ 11/3/16

The rule of 72 [Mohnish Pabrai]

David Rubenstein speaks with JPMorgan's Jamie Dimon [YouTube]

Charlie Rose interviews Amazon's Jeff Bezos [Charlie Rose]

When do you give up on a stock? [Oddball Stocks]

Pitch on Discovery Communications (DISCK) trading at 12x free cash [ContrarianEdge]

A framework for shorting the VIX [EconompicData]

The competitive advantage of an owner-operator [Base Hit Investing]

Winning at trading by being different [Brett Steenbarger]

China can resist a crash but can't prevent one [Bloomberg View]

Beware of the low stock price illusion [ETF]

Buy the housing dips [Dead Companies Walking]

The science of why you should spend money on experiences, not things [FastCoexist]

The Role of Volatility Panel: Alpha Hedge West Conference

Next up in our series of notes from the Alpha Hedge West Conference is the Role of Volatility with a panel featuring Michael Schmanske of Glenshaw Capital, Christopher Cole of Artemis Capital, Zem Sternberg of Lake Hill Capital, and Joe Reynoso of Reynoso Asset Management.


The Role of Volatility

JC> Volatility is the new asset class.

JR> Used to be that the dumbest guy bought options, now that's not the case.  Options now efficient for hedging.  

ZS> Think of not as an asset class, but as a specialization.

JC> Government is the elephant in the room.

CF> Volatility has normalized.  QE has impacted pricing of tail risk.  Some think Fed can suppress volatility, thinks that is a myth.

JR> Seems like volatility is moving similar among asset classes.  Fed won't let market crash.

CC> Financial repression.

ZS> Brokers & Liquidity providers make money in options, those are the proven models.  Don't ignore the info the options market give, even if you don't trade it.

CC> Key is valuing the expectation of volatility.  Game theory is key.  Life is decay.  The more people short VOL, the more risk for a spike.

ZS> Think of options as insurance.  Move from Newtonian world to quantum mechanics.

Be sure to check out the rest of our summary of the Alpha Hedge West Conference.

Put/Call Ratio, Volatility Index (VIX), and 50 Day Moving Average

Over on his blog, Stewie has pointed out that the put/call ratio has leveled off and implies a level of comfort from the bulls.

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But, we are also seeing a decline in volatility (VIX). Typically, such a move triggers a rise in stocks. But, instead, you have a market which is basically churning sideways.

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So, the combination of a declining put/call ratio, a declining VIX, and sideways market action could actually be a bad sign for the bulls. Not to mention, you've got the end of a year, the holidays, and typically light volume in the markets. Lastly, don't forget that we're also trading right around an area of resistance as many stocks and indexes run right into their 50 day moving averages.

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We've noted that as everything trades up into their 50 day moving averages and overall levels of technical resistance, we think it sets the market up for another leg down. And, as always, we would love to be proved wrong by some catalyst or spike above resistance with volume. But, until we see that, we will continue to await the next drop. Overall, we think this is a very key point in the markets. We are in an overall downtrend, and have seen a counter-trend rally up into resistance. If the market can break through, it could really change the game up. We are weighted slightly to the short-side as it is our inclination that resistance will hold. We would normally be more heavily weighted to the short side here, but we don't feel comfortable "anticipating" a move due to the circumstances (holidays, light volume, new administration, & crazy market in general). Instead, we'll wait for miss market to tip her hand, and then play in that direction.

Signals Popping Off the Charts

Just a quick excerpt from Quantifiable Edges,

"What needs to be kept in mind is that the price action over the last week has been more severe than at any time other than 1987 and then back to the 1930’s. In other words, while extreme readings in breadth, volatility, price, and volume indicators of this magnitude have almost always led to short-term upside over the periods tested, the current situation is far beyond most everything tested. Measures need to be taken to control risk. Tight stops are a possibility, but difficult to implement with such extreme volatility. I’m controlling risk by scaling in with reduced position size."

VIX : Historical Volatility Comparison

Many people were quick to note the Volatility Index surging as the market plummeted. So, where do current VIX levels compare to other crises? Maoxian has a great chart up illustrating just that.

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Now, the ultimate question becomes: where does the current crises fall on the list in terms of severity? Worse than the '87 crash?

Source: Maoxian

Gauging Fear in the Markets: Put/Call Ratio and Volatility Index (VIX)

Two fear gauges many people use in the markets are the Volatility Index (VIX) and the Put/Call Ratio. And, both are getting close to levels that historically signal the intense fear in the markets we've seemingly been waiting forever for. Why are we waiting for such fear? Because it typically marks an opportunity.

First, my man Stewie has a great Put/Call chart up illustrating the historical levels of the ratio. As the ratio reaches 1.20, you can see that it has coincided with market lows/tradeable bottoms. So, while the market is down big and there is some level of fear... there is no true panic yet. The assumption would be that we are well on our way to true panic and levels of 1.20 on the Put/Call Ratio. If this becomes the case, I would look to start buying a few names for a trade at the very least. Don't ya just love buying when there's blood in the streets? As the chart illustrates, those levels on the ratio have marked tradeable bottoms (but not THE bottom). This is pure chart candy right here:

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Secondly, VitalTrends has the historical Volatility Index (VIX) chart posted up for us. Typically, as the VIX blasts past 30, a strong level or fear sets in. And, once you get as high as 35-37, panic and capitulation often occurs. Now, that's not to say that we could always go even higher on the VIX and reach even new levels of fear. But, historically, a VIX of around 37 has been a tradeable bottom as it marked intense fear and capitulation. If you were to overlay this chart with a chart of the market, you would find that those spikes in the VIX would coincide with tradeable bottoms in the market (but not THE bottom).

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The point of gauging fear? Opportunity. Should panic truly set in, we should have a very tradeable bottom on our hands (emphasis on 'tradeable,' as this is not THE bottom). We'll see what happens.


Sources: Stewie and VitalTrends

Long Volatility

Target: $34. Goal: pure panic. Unless we get a major market rally that can drop the VIX out of its channel, we are still on the (slow but steady) road to continued volatility.

Odds & Ends

I've got a couple random/unrelated topics to cover so I just decided to mash them all up into one post.

1. Capitulation. Everyone and their dog is looking for it, and frankly, that makes me think we won't get it for some time. If everyone is waiting for everyone else to panic and sell, then who is actually going to be selling? It used to be that not many people paid attention to the Volatility Index (aka the VIX), but as the year has gone by, you see more and more people referencing it. It now appears that literally everyone is watching it. And, apparently there is a disconnect between the VIX and this market tumble (more on that later). At any rate, the VIX did spike on this morning's sour open. It spiked to 31 but then quickly retreated back down, laying down a nasty inverted hammer on the chart. We'll see how the rest of the day/week plays out.

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2. Mosaic (MOS) has sold its nitrogen business (Saskferco) to Yara International for $1.6 Billion (courtesy of Bloomberg here). I suggested in one of my previous posts that MOS was essentially 'top-ticking' or selling the top in the nitrogen trade, as they wanted to focus more on potash and phosphate. Although the stock is down on the news, this is a very buyable dip, as it will further their bottom line down the road. Nitrogen, although a strong part of their business, is not seeing the ideal pricing power conditions as their potash segment is. Again, my thesis on these fertilizer plays all along has been to play them due to their potash exposure; nitrogen and phosphate were only added bonuses. The potash segment has very limited supply and strong demand worldwide. And, add in the fact that new supply cannot be brought to market for years, and you've got the ideal combination for $$$.

3. Google (GOOG). On the chart, many of you know that this thing has a nasty gap to fill all the way down around $480. Yesterday, GOOG broke down past $520 and gave me the signal to short. However, they do have earnings coming up and that could obviously be a catalyst in either direction. So, for the mean time, instead of straight up shorting GOOG, I've put an option strangle to work. (If you're unfamiliar with a strangle, it's essentially an options position that makes money only if the underlying stock makes a big move in either direction. You can read more about it via Investopedia here). I was going to play a straddle on this name, but GOOG options are ridiculously expensive and so even playing a strangle (typically cheaper since you're using out of the money options) is still expensive. So, yesterday, I entered into the strangle of GOOG 480 Puts and 560 Calls. Obviously, with GOOG trading down again today, the put side of the trade is making money, while the call side is not. If GOOG continues to trend downward, I may just take profits before earnings altogether. But, we'll just have to see how that plays out. I had drawn up this chart last week and intended to post it as a short, but I completely forgot. This first chart is the GOOG chart I drew last week. The second chart will show where GOOG sits currently. Since marking on that first chart, GOOG has fallen from $560 to $505, a pretty strong move to the downside. Here's the chart I drew a little while back.

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And, here's what GOOG looks like now.

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So, as you can see, GOOG has fallen pretty hard and could very well continue down and fill the gap at $480, as that is our final goal. Keep in mind though that earnings are coming up and could provide a massive catalyst for this stock to swing violently in either direction. That's why instead of just shorting it, that I have put on the strangle, to hedge myself.

4. The trend (is still) your friend. Seeing as how that phrase was the Quote of the Week for this week, I found it very appropriate to post yet another great up-trending chart in this shitty market. Central European Distribution Company (CEDC) came up while I was researching new plays in Central Europe/Eastern Europe/Russia. Taken from Google Finance:

"Central European Distribution Corporation (CEDC) is an integrated spirit beverages business. The Company produces vodka at two distilleries in Poland and is a distributor of alcoholic beverages. The Company is also an importer of spirits, wine and beer in Poland. Its products are also exported out of Poland. CEDC offers a portfolio of alcoholic beverages with over 700 brands."

I'll be doing more research on this name, but you simply cannot ignore a great chart. Pull up any time frame: 1 month, 3 month, 6 months, 1 year.... they all look the same:

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That wraps up the odds & ends for now.