If so, the short sellers will accrue income from those option premiums. Selling options has been a 'money trade' for the last couple of years and like all winning trades in financial markets, profits attract a crowd. Being short any financial instrument carries considerable risk.
But options can be particularly risky because of the potential for exponential losses if things don't go your way.
Professor Succo suggests that the options market now resembles the period leading up to that event and that if this trade starts going against the short sellers, the door won't be big enough for all those who want to exit this crowded trade. What would this look like? Well, one scenario looks like this.
Something e. Those who are short put options would start buying those puts back in big size to cut their losses.
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The stampede for the exits could cause a selling cascade that could dislocate financial markets. I'm in no way saying that this will happen. But informed market participants should be aware of this scenario and factor it into their probability spectrums. Hard to figure the potential economic benefits to Google from this transaction, seeing as YouTube sports little in the way of revenues and zero profits.
But, hey, the YouTube founders sure are happy! For what it's worth and it's probably not much , deals like remind me of the crazy days of the tech stock bubble in In Professor Zucchi's first bullet point here , he notes that 'buy programs' are currently driving stock market prices higher. Here's the sequence.
You are now 'long' the contract while the dealer is 'short' it. So the dealer is now hedged: short the index futures contract, but long all the individual stocks that compose the index dealers are happy because you pay them commissions or related fees when you buy the index products. So what Professor Zucchi is saying is that the market is being driven higher by an abnormally large amount of buying of index products which subsequently causes dealers to hedge via buy programs.
Stated another way, stock prices are going up primarily because stock market indexes are being bought rather than the individual stocks that compose the indexes.
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Why might this matter? In the past, high levels of indiscriminant index buying has often not been a sign of healthy market advances. Todd notes that the market has been shaking off lots of negative news and moving higher. Many folks suggest that it is bullish when markets respond positively to negative news. Perhaps, cookie. But I'm also reminded of Professor Succo's recent observation that markets often get it 'wrong' at extremes. And one look at the price movements in market indices over the last coupla months could be viewed as extreme.
I'm not sure which view is right, but as always you want to see both side of the trade. After all, what happens when central banks and the governments that they are affiliated with 'own it all'? A Minyan asks Todd whether the 'Ville has been too bearish in lieu of the recent stock market move higher. Todd says maybe, but suggests that the real objective is to see both sides of the trade --something that is often missing from conventional financial media channels. Fear of missing out on further gains once prices have already moved away from you is a classic emotional response in financial markets.
Do you think this is wise? Professor Succo is one of the best 'tape readers' on Wall Street. Tape readers are individuals who possess excellent 'feel' for price behavior in markets.
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This sense is obtained from years of watching stock price movement on a minute by minute basis in the early days, these prices would be printed on a ticker tape to read, thus the term 'tape reader'. A year ago, John began sharing observations about large 'program buyers' who were putting a bid under stock prices see this post , for example.
Yesterday, Professor Succo noted that those buyers are still there in a big way, and opined that their price insensitivity suggests 'non-economic' entities--such as central banks or other government agencies--as potential sources just so you know, here in the US it is illegal for the federal government or its affiliates such as the Federal Reserve to buy stocks. Today, Succ expanded on this thought. In his view, it is very plausible that governments, particularly foreign central banks, are using the mammoth quantities of paper currency they are printing to buy stocks.
If true, of course, it means that governments are interfering with the market mechanism. Can such a cause and effect go on forever? Succo thinks not. In fact, he suggests that it's adding more risk to the financial system. You don't have to embrace this viewpoint, but you should certainly want to 'see' this perspective in order to understand both sides of the trade. Personally, I get a ton of value from Succ's observations about the ebb and flow of market prices on a tick-by-tick basis--even though I'm not an active trader. To me, a solid big picture, long term perspective is best built by observing and learning from the granular, intraday market action.
Brick by brick, cookie.
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Stock markets can be great indicators of future economic activity because people are betting on the future using real money. Individuals with good information see things that others don't and stocks begin to discount good or bad news before it becomes evident. However, the market sometimes gets it wrong--particularly at extremes. Professor Succo notes that emotions and bad information can cause markets to get it wrong. Succ opines that he thinks this is what's happening now--meaning that risk is high. This is an important post--one that merits rereading until you get it.
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From the charts below, observe that market participants have been moving away from commodities in favor of financial assets such as bank stocks. Professor Pomboy questions the intelligence of this move. Professor Reamer reminds us the since markets are essentially collections of crowds, they often favor emotions over intelligence. Keep this in mind the next time you observe market behavior that 'doesn't make sense. I'm reminded of a quote attributed to the economist John Maynard Keynes: "Markets can stay irrational longer than you can stay solvent.
Charts courtesy of StockCharts.
Nice little primer on the Fed's role in creating liquidity. Please be aware that rarely if ever in the history of the world has liquidity been so high the Fed and other central banks around the world have been pouring liquidity into the system. There is risk to generating all this liquidity, and as Succ notes at the end of his post , currently that risk is very high.
Professor Succo notes that Bank of America was caught laundering drug money but district attorneys won't pursue it out of fear of putting banks out of business. Say what? Seems like the equivalent of a get out of jail free card to me. In fact, if you look at a monthly chart below , the Dow indeed closed out September at an all time high on a monthly basis.
Party time? However, Toddo reminds us that there are a number of issues that suggest that you should keep your guard up. Professor Sedacca suggests that buying large stocks under the perception that they are safe and liquid has at times been very wrong. Be careful out there and make sure you see both sides of the trade. That chart appears below and suggests a significant decline pending for stocks if this relationship holds. One concept you'll see noted alot on the 'Ville example here is 'volatility' or just 'vol'.
Simply stated, volatility is price movement. There are two types of vol. Actual vol is the historical movement in a security's price often measured by some form of that old statistical workhorse called the standard deviation. There is also implied vol. Implied volatility is the estimated future movement of a security's price derived from option prices just how this is calculated is a subject for another day. You can see that vols have been declining since early to historically low levels and as Todd notes, it's currently wearing a '10 handle'.
Why should you care? Well, currently the market is voting that the future portends relatively little in the way of movement. In fact, market participants have been aggressively selling options volatility at these already depressed levels. Because prices haven't moved with all this volatility selling, Professor Succo wonders whether market participants aren't becoming too complacent about the potential for big movement in the near future.
Selling vol at such low prices remember, you'd rather want to buy low and sell high seems the very definition of complacency.
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So, by this measure market participants seem complacent. If it's true that financial markets tend to penalize complacency, then, well, you connect the dots Are Lower Prices Good News? Most of us have seen the lower prices at the gas pumps recently. In fact, as noted in the chart below, prices of commodities in aggregate have significantly declined after a multiyear trend higher. Good news, right?
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