Observations & Insight
The Spread – The Colo Down-low – 9/7
“The Spread” hasn’t covered Aurora, Ill. during its time on the web. We tick that box in this week’s recap.
Bad bets offer a cautionary tale to investors; Second-guessing the volatility of markets can be costly
Brendan Geeley – FT (SUBSCRIPTION)
Over several days in early February of this year, two retail exchange traded products lost more than 80 per cent of their value. Close to $3bn was wiped out. One product, which traded as XIV, was liquidated. The other, SVXY, now sits at about a tenth of its pre-February high.
Both employed a collection of financial options to offer similar products: bets that financial markets would remain stable. However, after a US data release that suggested higher inflation upset markets briefly, these bets collapsed. A month later, in a summary of the event, the Bank for International Settlements concluded that the episode offered “a stark reminder of the outsized risks involved in speculative strategies using complex derivatives”.
****This article is part of a larger FT Report – Special Report: Exchange Traded Funds
Barnier sends sterling to a five-week high on Brexit deal hopes
Sterling surged against the dollar and euro on Monday after the European Union’s chief negotiator said a Brexit deal was “realistic in six to eight weeks”.
****SD: From the story – “It just shows that’s the key thing that people want to see — Brexit progress. You have a market that’s heavily short on sterling due to Brexit. It needs that tail risk to be taken off before sterling can rally,” said Viraj Patel, a currency strategist at ING in London.
Consolidated Audit Trail Go-Live Now Appears a Certainty
Adam Dix, Kx – Tabb Forum
Despite criticisms surrounding cost, complexity, security and even need, the SEC’s Consolidated Audit Trail is now cleanly sprinting toward the end zone – developments toward its ‘go-live’ have strengthened considerably in recent months. Kx Regulatory Reporting Director Adam E. Dix provides an update on the status of the regulation, which will improve the ability of the SEC and Self-Regulatory Organizations more effectively oversee the US securities markets.
****SD: If you’ve been out of the loop, this piece offers a comprehensive catch up.
The Financial Crisis Made Us Afraid of Risk – For a While; Risk-taking never disappears, it just changes shape, often to slip past the institutional and psychological defenses erected after the last crisis.
Greg Ip – WSJ (SUBSCRIPTION)
Ten years ago this month, the failure of Lehman Brothers exposed how cavalier the world had been towards risk. Households had bought homes they thought could never go down in price, banks had made loans they thought would never default and repackaged them into securities to make them seem riskless and governments, convinced depressions were a thing of the past, had stood by.
The Next Recession: Three Critical Warning Signs
Bluford Putnam and Erik Norland – CME Group
The next recession: What are the warning signs? What might it look like? How will markets react? The nearly decade-long U.S. economic expansion may look a little long in the tooth, but it is not about to end due to old age. Economic expansions need a catalyst that triggers a downward spiral of consumer and business retrenchment. The most common recession catalyst for the United States has been the collision of rising interest rates with heavy debt loads, corporate valuations that appear to have run ahead of free cash-flow generation, or both. Add trade tensions and geo-political uncertainties, which may work to slow global growth, and it seems like the current situation has the potential to trigger a recession.
Volatility White Papers and Presentations
Vance Harwood – Six Figure Investing
Below I’ve collected links to some of my favorite white papers and presentations on volatility.
Carbon Options Signal 20% Gain as Europe Nears Record Price
Andrew Reierson and Mathew Carr – Bloomberg (SUBSCRIPTION)
HSBC among latest forecasters to predict further gains; Calls showing growing appetite for 30-euro carbon next year
Even after surging more than any other major commodity this year, the runaway rally in European carbon futures won’t halt any time soon, if you believe the options market and a growing chorus of analysts and traders.
Exchanges and Clearing
Abu Dhabi Stock Exchange Aims to Start Futures Trading Next Year
Filipe Pacheco – Bloomberg (SUBSCRIPTION)
Contracts to begin with single stocks, may be widened to index; CEO Rashed Al Blooshi comments on derivatives in interview
Abu Dhabi’s stock exchange is joining a race to introduce derivatives as Gulf bourses including Kuwait and Saudi Arabia put strategies in place to lure more investors.
****SD: Options to come in 2020.
SGX reports market statistics for August 2018
…Total Derivatives volume was 18.79 million, up 11% month-on-month (m-o-m) and up 18% year-on-year (y-o-y).
Proposal to amend its rules relating to categories of registration and respective qualification examinations required for Trading Permit Holders and associated persons.
…The Exchange proposes to require that effective October 1, 2018, new applicants seeking to register in a representative capacity with the Exchange must pass the SIE before their registrations can become effective. The Exchange proposes to make the requirement operative on October 1, 2018 to coincide with the effective date of FINRA’s requirement.
****SD: SIE stands for the Securities Industry Essentials Examination.
Too early for volatility index in Brazil – panel
Louisa Chender – Global Investor Group (SUBSCRIPTION)
Getting more liquidity on the IBOVESPA should be a key focus for the Brazilian exchange, a panellist said
Zhengzhou Commodity Exchange hopes to launch cotton options by year-end – media
Zhengzhou Commodity Exchange hopes to launch cotton options by the end of the year, Wang Xiaoming, deputy manager at the exchange, said at a conference, according to the Securities Times.
Deutsche Boerse Group expands its engagement in Asia
To further strengthen its activities in China, Deutsche Boerse Group teams up with Zhengzhou Commodity Exchange. The strategic partnership will focus on the futures market and is intended to create a strong bond between Zhengzhou Commodity Exchange and Eurex, Europe’s largest derivatives exchange that is part of Deutsche Boerse Group.
Regulation & Enforcement
JP exec calls for derivative margin changes; Move follows 13 significant margin breaches in 2018, with one breaching by as much as 245%
Robert Mackenzie Smith – Risk.net (SUBSCRIPTION)
JP Morgan’s head of clearing, Nick Rustad, is calling for changes to the initial margin regime, to take into account developments in market structure in the wake of new data showing there have been 13 significant margin breaches in listed derivatives markets so far this year.
The Fiduciary Rule Is Dead. What’s an Investor to Do Now?
Lisa Beilfuss – WSJ (SUBSCRIPTION)
With regulations in flux, it’s a confusing time for those who work with investment professionals. Here’s what investors need to know.
Larry Summers Calls Fed Bank Stress Test Results ‘Absurd’
Craig Torres and Christopher Condon – Bloomberg (SUBSCRIPTION)
Ex-Treasury secretary calls for higher capital requirements; Summers comments come at Boston Fed conference on low rates
Interactive Brokers updates IB API software
Maria Nikolova – FinanceFeeds
The IB API now provides aggregated depth of market (DOM) quotes from the level 1 and level 2 feeds to which a user has subscribed.
People moves: BAML makes changes in derivatives clearing, Mattatia joins MSCI, RBS hires new CRO, and more
Catherine Hornby – Risk.net
Bank of America Merrill Lynch has made several senior appointments in its futures and options and over-the-counter clearing team, according to an internal memo.
Emerging Markets: Time To Play Smart Offense
Steven M. Sears – OCCAM
The list of struggling emerging markets keeps expanding, creating concerns among some institutional investors that a dreaded economic contagion may be forming as nations with dollar-denominated debts suffer as U.S. interest rates increase, and the dollar strengthens.
The primary proxy for emerging markets, the iShares MSCI Emerging Market ETF (EEM) is down some 20% since setting a 52-week high in late January. While the exchange-traded fund’s decline is the textbook definition of a bear market, the contagion threat seems contained, for now, but a pending Federal Reserve rate-setting meeting could prove pivotal.
****SD: Bloomberg has Central Bank Mettle in Focus as Dollar Saps Emerging Markets
‘This is January all over again’: Citi warns that another stock market meltdown is coming and details how traders can protect themselves
Akin Oyedele – Business Insider Prime (SUBSCRIPTION)
US stocks have a “3x higher likelihood” of negative returns over the next 12 months, Citi strategists warn. They observed a number of trends in the economy and options markets that mirror what transpired just before the correction in February.
The Collar Strategy – Stay Long & Hedge
Investors increasingly question how to manage their equity risk exposure as the equity market continues to extend the 9.5 year rally. Following the “Random Walk” theory, we know markets are subject to making unpredictable price movements and unlikely to go straight up. Retreating from the recent all-time highs, investors are faced with potentially increasing exposure to equity risk. There are several alternatives to be considered, such as accept current risk levels, portfolio rebalancing, or stay long and hedge that equity risk exposure.
A New S&P 500 ETF for Those Looking to Avoid Risk
Nathan Reiff – Investopedia
According to ETF.com, a new exchange-traded fund (ETF) specially tailored to investors who wish to avoid risk has recently launched. In the growing ETF space, companies listing new products have increasingly had to cater toward more and more specific interests. There are now ETFs for just about every theme one can imagine, from cannabis to video games. Innovator Funds is hoping to play to an inherent strength of the ETF as an investment vehicle: stability.
The new Innovator S&P 500 Buffer ETF (BJUL), listed on Cboe Global Markets, is designed with loss aversion at its core. BJUL invests in custom S&P 500 FLEX options with a variety of strike prices but the same expiration date.
The S&P Risk Parity Indices: Methodology
Berlinda Liu – S&P Dow Jones Indices
In earlier posts, we analyzed the historical performance, risk contribution versus capital allocation, and return attribution and leverage of the S&P Risk Parity Indices. The results demonstrate that this indices in this series could potentially serve as benchmarks to measure the performance of active risk parity strategies. In this post, we will dig deeper into the methodology and walk through our rationale behind the index rules.
Looking Backward, Thinking Forward
RCM Alternatives Blog
Here’s the Chicago Board of Trade’s trading floor sometime in the 1990s. Down there in that mass of humanity and paper and colored coats were dozens of clerks. These were (mostly) young people getting a foothold in the industry. Learning the ropes from the bottom rung. Interns, if you will, who weren’t just leaning how the markets worked, but also getting as good a look at pure speculation and capitalism as most will see – being offered $1,000 to eat a small tub of sport peppers one day or traders making a market on whether they could throw a football across the Chicago river the next.
Aluminum Risks Return to Crisis With Rusal Left Out in the Cold
Mark Burton and Yuliya Fedorinova – Bloomberg (SUBSCRIPTION)
Russian producer may need to cut aluminum output next year; Annual negotiations take place at Berlin industry gathering
The aluminum industry is running out of time to avoid another crisis as U.S. sanctions leave United Co. Rusal locked out of crucial contract negotiations kicking off this week in Berlin.
Most bonds don’t trade
Dan McCrum – Financial Times (SUBSCRIPTION)
A fresh piece of Citi research lands on bond market liquidity, which evokes a reminder of those days in late 2015 when a lot of attention was focused on how easy it was to buy and (more importantly) sell corporate debt.
Back then JNK and HYG, the two biggest high-yield bond exchange traded funds, had fallen to their lowest since 2009 after Third Avenue, a US asset manager, said it would shut down its $788m “Focused Credit Fund” after a wave of losses and investor redemptions.