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Bernake's Move:
The Beginning of the End of the Bear? |
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Ben Bernake went shopping
yesterday and bought a rally. In a move that would out spend even Bill
Gates, he pledged $200 billion of the government's money to buy a one day
short covering rally- so- was it a wise investment? Because, in reality,
he is spending our money to put some mechanisms in place to prevent the
United States from slipping into an even deeper recession.
Here's some clarity on the FED's
latest
move. Here's a chart I have been watching every week. It's rather obscure
and difficult to find, but it measures the current value of a portfolio
of AAA insured mortgage backed securities with a par price of $100.
As you can see, the bid price of
these perfectly good performing securities is about $55. Why?- because
huge institutions are being hit with margin calls and forced to sell into
a market with few or no buyers. Actually, there are buyers. I am hearing
anecdotally from friends in the trading pits on Wall Street that smart
money is swooping in to buy these securities at bargain basement prices.
And, even if these huge institutions are not forced to sell, they are being
forced to take huge write downs on their balance sheets as these values
fall.
It reminds me of the Dot-Com demise
in 2001 when institutions were forced to sell stocks as they fell below
price thresholds they were allowed to hold. I remember stocks trading at
$2 with $4 in cash and no debt. Wow, there were some bargains.
This is all causing a liquidity crises.
Low interest rates don't mean much if you can't borrow money. Banks need
to have capital and strong balance sheets to make loans. Here's how yesterday's
new program announced by the FED works:
The FED is going lend highly
liquid treasuries to banks and other huge financial institutions in return
for portfolios of AAA, mortgage backed securities. This will allow these
huge financial institutions to swap their loan portfolios for US Treasuries
for time periods of 28 days. The US Govt will take the risk of holding
these securities.
The FED holds about $713 billion
in Treasuries it can lend in this program. This should help these huge
financial institutions shore up their balance sheets and stop taking these
huge write downs- perhaps even start taking some write ups.
I'll be watching this chart weekly
to see if these bond portfolios start to rebound- this will be one sign
the Bear Market might be winding down. I also believe this unusual and
preemptive move by the FED is a precursor to next interest rate
reduction, which will help the economy in many ways.
Bernanke's move yesterday yielded
the 4th highest one day move in DOW in history. However, the short
interest is so huge, yesterday was just short covering. There is no sign
of new money, but it will come as soon as the market is convinced the recession
is six months from being over.
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Looking To Trade the Volatility?
Watch the VIX |
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You might have heard about the VIX,
and not understand what it is. The VIX is an index which attempts
to measure the levels of fear and complacency in the market. On Yahoo!,
you will find it under the symbol VIX-X.W. WWW.BigCharts.com just
uses VIX. Other quote providers will have their own symbols, and
you can symbol search for it. A chart is very helpful. I even get the current
quote in my iPhone.
If you are looking to make some short
term trades in this volatile market, one indicator to use is the VIX.
VIX
stands for "Volatility Index". It is derived from a complicated
formula of comparing put and call buying on the CBOE. In it's simplest
terms, when there's tons of put buying, which is a bet the market is going
down, the VIX goes up, implying significant fear levels. When the
VIX
is low, there is more call buying, suggesting less fear, or complacency.
I have been making a little money
scalping trades by buying put and call options on the QQQQ- the
ETF stock that trades up and down with the NASDAQ Comp.
Here's a chart going back to last
summer which shows an overlay of the VIX and the QQQQs. It
clearly demonstrates how they move in opposite directions. There is a clear
correlation between going long or buying a call on the QQQQs when
the VIX is very high, and going short or buying a put when the VIX
is low. The colored arrows indicate the extremes, and great entry levels
for the trades.
To simplify this whole thing, I'll
give you a couple of benchmarks. When the VIX is in the 30 range,
go long the QQQQs buy buying calls. When the VIX is down
around 20 or below, go short the QQQQs by buying some puts. These
are contrarian trades. You will be betting on the oversold and overbought
swings. You are betting those buying the extremes are dumb money.
These trades have been working for
some time. Here's how I do it. I missed Monday's move in the VIX
as it closed in on 30. However, had I been paying attention, I would have
bought some QQQQ calls. I will generally buy slightly in the money calls
about 1 month out. With the QQQQs slightly over $42 on Monday,
I would have bought the $42 April Calls, probably for around $1.50
to $2. 50 calls would have run $7500, and would probably be up about $.75
now- worth $10k or so. The timing would have been perfect.
On these kinds of trades I am very
quick to pull the trigger when I get in the money. I don't like to shoot
for too much, and am happy to scalp a quick profit.
As I write this edition, the VIX
is at 26.45- no man's land. If I had been paying attention and bought
on Monday, I probably would have closed out on yesterday's big rally, and
be in cash today.
With the VIX at this level,
there's nothing to be done right now. However, the next time we move to
an extreme level, I'll try to suggest a trade. In the meantime, keep an
eye on the VIX if you are interested in short term trades on the
extreme volatility we are experiencing.
If you want to learn more about trading
these kinds of options, I suggest calling your brokerage firm for more
information. Another good resource for Options Trading 101 can be found
at http://www.option-trading-guide.com/.
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