Credit deflation and the reflation cycle to come (part 2)

[DoINeedOne]

Part of a newsletter 

During the 2000-2010 decade, the S&P 500 energy sector dramatically outperformed the broader S&P 500 index:

However, during the 2010-2020 decade, the situation reversed, and energy stocks remained nearly flat with a “lost decade”, particularly during the second half, while the broader S&P 500 soared:

It has gotten to a point where a single company, Apple, has a larger market capitalization than all energy companies in the S&P 500 combined, which has never happened before.

 

 

[Festival]

3 hours ago, CVG said:

Just to repeat what I said earlier. You want Long Term UK Gilts - not Company Bonds - if you are following the portfolio.

Thanks CVG for the clarification. I have a mix of UST, Corporate and EM bonds atm. I'll be selling corporate bonds soon and picking up more UST's. I dont have any Uk gilts but i guess they and UST's perform a similar function currency aside.

[MrXxxx]

5 hours ago, CVG said:

philosophy behind the stratgey (I think) is that during a recession money floods out of equities and into safe harbours like gilts. Equities down - Gilts up. You already have an allocation to gilts so your losses on equities are offset by gains on gilts and hence your overall portfolio is less volatile. In addition, with rebalancing, you'll then sell Gilts (which are now overweight in your portfolio) to buy Equities (which are now underweight) to even up the allocations - thus selling high and buying low

This is the `theory` yes, and appears right for most recession BUT I thought (and have read somewhere) not for depressions/crashes, where both tumble...was this not the case in the GFC of 2008?

[MrXxxx]

5 hours ago, Festival said:

I cant see any real value in corporate bonds for the risk you take

The obvious one to me is the `security` of the initial capital I.e if the company goes tits-up bond holders are first in line as creditors whereas shareholders are at the end of the queue.

[MrXxxx]

5 hours ago, MvR said:

If you're happy to give up unlimited potential upside ( as you are if you're considering bonds ) you can effectively exchange it for a small income by selling options.

e.g.   XOM, currently at $59.13, and has a dividend yield of £3.48 per share or 5.81% yield.

A slightly out-of-the-money (OTM) put option for March expiry, in this case a 57.5 strike, is priced around $0.81 per share, or 1.4% of the underlying share price. The delta on this option is around 0.2, which means there is roughly 20% chance of the put option ending up in--the-money (i.e. the underlying price falling below the option's strike price ) and being exercised.

So, you could sell a put, and either pocket the premium if XOM never drops below $57.50 ( but not ending up holding any stock ), or get put the stock at $57.50, having pocketed the premium, leading to a net purchase price of $56.69,  or $2.44 better than buying the stock at the current price. That's a 4.21% discount against the current price, almost matching the dividend yield. 

So it's either a discount purchase, or $0.81 per share for simply being willing to own the stock.  If the put isn't exercised before it expires, it becomes worthless and you sell another one for the next month.  If you are exercised and get put the stock, you can then sell a call option against it, expressing your willingness to have the stock "called away" at the call option's strike price.  ( or you could just hold on to it if you think it's bottoming out ).

Depending on how keen you are to actually hold the stock, you can choose strike prices that are more or less likely to be hit, or bias your position to be more or less bullish overall.

In the above example, the 20% chance of being exercised means you'd expect to have to sell a few put options over consecutive months before one is exercised, and often you end up collecting more in premiums before entering a stock than a year's dividends on that stock.

Depending on how things pan out, you can generate a decent "yield" on any US traded stock or ETF this way.. between 4-10% relatively easily, and often more. Of course the drawback is you may not be in the stock when it makes a big move up, and you're still exposed to the downside.. there's no free lunch, but in a way it's much like DB's laddering strategy, trading some potential upside for a potentially lower cost-basis on entry.

 

 

Whoah there, I am a newbie!...so, just to make sure I understand the basis of options trading, and what you have written...

1. You buy a -Put option (the right to buy a share at a given price if you wish [in this case $57.5]]) with a transaction cost of $0.81 ps.

2. If the price falls below $58.31ps during your option period you are in the money (accounting for fact of Put fee) BUT if it doesn't during this period you have `blown` your $0.81 ps. I appreciate for the Put to be exercised the physical share price would need to fall below the Put price ($57.5).

3. If it goes below $57.5 you can either

a) cash it in to collect whatever the current ps price is below your Put value ps [ $57.5 ps], or

b) buy the shares at the market price, and also buy a Call option (the right to sell a share at a given price say $59.15 [$58.31 + Call fee cost of say $0.84ps]) to protect you bottom end just in case the shares continue to fall...

 

...and the advantage of Options route is that unlike either buying stocks/shares long or short, you investment losses are only limited to the Put/Call option fee ps?...basically the Put option is like a limited shorting, and a Call option is like a limited buying long,  the disadvantage is that if you picked a winner (either long or short) your profits are reduced due to the Put/Call fees over time eating into your profits.

...have I got this right?

[Wheeler]

3 minutes ago, MrXxxx said:

Whoah there, I am a newbie!...so, just to make sure I understand the basis of options trading, and what you have written...

1. You buy a -Put option (the right to buy a share at a given price if you wish [in this case $57.5]]) with a transaction cost of $0.81 ps.

2. If the price goes above $58.31 ps during your option period you are in the money BUT if it doesn't during this period you have `blown` your $0.81 ps.

3. If it goes above $58.31 you can either

a) cash it in to collect whatever the current ps price is avove your Put value ps [ $57.5 ps], or

b) buy the shares at you Put price, and also buy a Call option (the right to sell a share at a given price say $59.15 [$58.31 + Call fee cost of say $0.84ps]) to protect you bottom end.

4. If you then do 3b and it continues to rise you can then add further Call options (increasing the ps value each time) to protect your position as each Call option expires.

...and the advantage of Options route is that unlike either buying stocks/shares long or short, you investment is only limited to the Put/Call option fee ps?...but the disadvantage is that if you picked a winner (either long or short) your profits are reduced due to the Put/Call fees..

...have I got this right?

Sorry no @MrXxxx, you've got it backwards.

1. You sell a put option for the $0.81 that gives the buyer a right to sell you the share at a given price. You keep the $0.81 regardless.

2. If the price stays above the given price then the option will expire so all you gain is the $0.81.

3. If the price drops below the given price then the buyer of the put option will sell you the share at the agreed price. This will be higher than the current market price but you will have the $0.81 to compensate.

As a simple example: ABC is trading at $40 a share.

You sell a put option valued at $35 and get $1 for the put option. If ABC stays above $35 then you keep the $1. If ABC drops to $35 then you get the share sold to you for $35 but still keep the $1, effectively making the cost of a share $34. 

 

[MrXxxx]

38 minutes ago, Wheeler said:

Sorry no @MrXxxx, you've got it backwards.

1. You sell a put option for the $0.81 that gives the buyer a right to sell you the share at a given price. You keep the $0.81 regardless.

2. If the price stays above the given price then the option will expire so all you gain is the $0.81.

3. If the price drops below the given price then the buyer of the put option will sell you the share at the agreed price. This will be higher than the current market price but you will have the $0.81 to compensate.

As a simple example: ABC is trading at $40 a share.

You sell a put option valued at $35 and get $1 for the put option. If ABC stays above $35 then you keep the $1. If ABC drops to $35 then you get the share sold to you for $35 but still keep the $1, effectively making the cost of a share $34. 

 

Thanks Wheeler, so are you not taking a massive risk for that dollar I.e if you've sold the Put at $35 for a $1 fee, the share price then drops to $2 and the buyer takes the option, then its cost you $34 ($35-1) for something that is now worth $2! ...I assume that your also have to put up a bond to stop you reneging in such situations?

[Wheeler]

4 minutes ago, MrXxxx said:

Thanks Wheeler, so are you not taking a massive risk for that dollar I.e if you've sold the Put at $35 for a $1 fee, the share price then drops to $2 and the buyer takes the option, then its cost you $34 ($35-1) for something that is now worth $2! ...I assume that your also have to put up a bond to stop you reneging in such situations?

That's correct. There are complicated strategies to limit the downside risk - you could buy a put at $32 for say $0.50 then if the share price drops below that then you still make $0.50 (the $1 for selling the original minus the $0.50 for buying the $32). It reduces the gain you can make but limits the loss to buying a $32 share for $34.50. 

You do need to have the funds/collateral in your account.

 

[MvR]

18 minutes ago, MrXxxx said:

Thanks Wheeler, so are you not taking a massive risk for that dollar I.e if you've sold the Put at $35 for a $1 fee, the share price then drops to $2 and the buyer takes the option, then its cost you $34 ($35-1) for something that is now worth $2! ...I assume that your also have to put up a bond to stop you reneging in such situations?

Basically yes, although if you had an inkling the stock price might fall from $35 to $2,  you'd probably not be selling puts in it.  Selling the put options leaves you with the same downside risk as buying the stock outright, but you've pocketed the $1 put premium to at least cushion the blow a little.

And yes, you do need to put up collateral.. essentially the cash in your account. How much depends on the broker's calculation of the risk involved, but it's usually around 10% of the underlying stock value.  You can reduce this collateral ( margin ) requirement by buying a protective put further out-of-the-money from the one you sold, limiting you risk to the difference between the strike prices, minus the net premium you receive.

[Errol]

Russia keeps stockpiling gold as bullion prices continue to surge

Russia has continued filling its coffers with gold, having added almost 7 tons of the precious metal to its reserves in January. The country's total gold holdings amounted to 73.2 million troy ounces (2,276.8 tons) as of February 1.

https://www.rt.com/business/481298-russia-gold-reserves-growth/

 

[Loki]

Wish I'd stocked up a bit more at £940/oz.  

[MrXxxx]

1 hour ago, MvR said:

Basically yes, although if you had an inkling the stock price might fall from $35 to $2,  you'd probably not be selling puts in it.  Selling the put options leaves you with the same downside risk as buying the stock outright, but you've pocketed the $1 put premium to at least cushion the blow a little.

And yes, you do need to put up collateral.. essentially the cash in your account. How much depends on the broker's calculation of the risk involved, but it's usually around 10% of the underlying stock value.  You can reduce this collateral ( margin ) requirement by buying a protective put further out-of-the-money from the one you sold, limiting you risk to the difference between the strike prices, minus the net premium you receive.

Thanks, so if you bought a lower protective put yourself, is this then conceptually like a reverse safe short where you are limiting your liability for losses?

[MvR]

9 minutes ago, MrXxxx said:

Thanks, so if you bought a lower protective put yourself, is this then conceptually like a reverse safe short where you are limiting your liability for losses?

I'm not sure what you mean by a "reverse safe short",  but yes, you are limiting your maximum loss.

e.g.  stock = $35.  Sell an at-the-money put, 35 strike, say 45 days to expiration, for $1, and buy a 30 strike put for $0.20.  You receive a net credit of $0.80, and you maximum downside is (35-30) - 0.80 = $4.20 per share.

You would either lock in this loss by exercising your long put if the price drops below 30, or if you wanted to keep the stock, you could sell the long put instead of exercising it.

 

 

[Democorruptcy]

Can any of the option traders on here recommend a decent book on it?

[MrXxxx]

13 minutes ago, MvR said:

I'm not sure what you mean by a "reverse safe short",  but yes, you are limiting your maximum loss.

e.g.  stock = $35.  Sell an at-the-money put, 35 strike, say 45 days to expiration, for $1, and buy a 30 strike put for $0.20.  You receive a net credit of $0.80, and you maximum downside is (35-30) - 0.80 = $4.20 per share.

You would either lock in this loss by exercising your long put if the price drops below 30, or if you wanted to keep the stock, you could sell the long put instead of exercising it.

 

 

Sorry I wasn't very clear in my explanation.

So, with a short you are betting on the market price dropping by borrowing shares, selling them at todays price, and then buying them back again tomorrow at a lower price. The problem is they could rise, and there is no ceiling to their height.

By offering a Put you are doing the short in reverse, where if the share price falls rapidly below your Put price you are a loser, as the holder will be able to sell a share to you at a price that is higher than the much lower market value. The advantage/difference to a short  though is that you have a base I.e the shares market price cannot go below zero (so this is the same as just buying the share yourself) but you will always have their Put fee, OR you can position the base between the Put price you offered (and had to buy at) and a lower limit by buying a Put yourself.

Not sure if I have made this any clearer for you to understand what I am trying to say, but by writing it out its clarified it in my head! :-) :-) :-)

Thanks for your patience! :-)

[MrXxxx]

8 minutes ago, Democorruptcy said:

Can any of the option traders on here recommend a decent book on it?

I am currently reading a couple of FA & TA chapters in a book called `Options made Easy` by Guy Cohen (Pearsons/FT press) before I get into the Options chapters...but looking at my recent posts on this subject I am probably not the best person to recommend whether this is a good text or not :-) :-) :-)

[MvR]

14 minutes ago, MrXxxx said:

Sorry I wasn't very clear in my explanation.

So, with a short you are betting on the market price dropping by borrowing shares, selling them at todays price, and then buying them back again tomorrow at a lower price. The problem is they could rise, and there is no ceiling to their height.

By offering a Put you are doing the short in reverse, where if the share price falls rapidly below your Put price you are a loser, as the holder will be able to sell a share to you at a price that is higher than the much lower market value. The advantage/difference to a short  though is that you have a base I.e the shares market price cannot go below zero (so this is the same as just buying the share yourself) but you will always have their Put fee, OR you can position the base between the Put price you offered (and had to buy at) and a lower limit by buying a Put yourself.

Not sure if I have made this any clearer for you to understand what I am trying to say, but by writing it out its clarified it in my head! :-) :-) :-)

Thanks for your patience! :-)

No problem:) Yep, you have it exactly right.

 It's always a bit of a head-fuck to start with, and there's no substitute for trying them out to really get a feel for how they trade and how their prices fluctuate, but once you grok it it's really straightforward.  I always suggest people immerse themselves in www.tastytrade.com for a few weeks to learn the basics. 

17 minutes ago, Democorruptcy said:

Can any of the option traders on here recommend a decent book on it?

I'd start here.  It's all free, and their brokerage, Tastyworks, by far the best beginners' platform, as well as the cheapest :-

https://tastytrade.thinkific.com/?utm_campaign=learn_center&utm_source=tastytrade&utm_medium=website&utm_content=learn_more&utm_term=header_learntab

 

[BearyBear]

3 hours ago, Democorruptcy said:

Can any of the option traders on here recommend a decent book on it?

Options as a strategic investment is good for a start I think

[Loki]

Does anyone have anymore thought on the price of gold and silver? (Not miners)

Gold is now the highest it has ever been in GBP

[BearyBear]

Gold has produced a bullish weekly bar, I think it should easily reach 1795-1800 area in a few weeks time where I'm expecting at least a pause.

Levels to watch: 1700, 1755, 1800.

[BearyBear]

Silver is pretty much disappointing as it's still trading below the 19.60 level (high of last year) and I can't see that much potential on the upside as Gold has.

Levels to watch: 18.85, 19.60, 21.10

[Noallegiance]

41 minutes ago, BearyBear said:

Silver is pretty much disappointing as it's still trading below the 19.60 level (high of last year) and I can't see that much potential on the upside as Gold has.

Levels to watch: 18.85, 19.60, 21.10

The Zhang theory is that silver is well off of competing the cup and handle that gold just completed. When it does, look out above if the g/s ratio is to get back to nearer 'normal'.

[dgul]

1 hour ago, BearyBear said:

Silver is pretty much disappointing as it's still trading below the 19.60 level (high of last year) and I can't see that much potential on the upside as Gold has.

Levels to watch: 18.85, 19.60, 21.10

The saying is that silver is always late to the party.  

I'm not currently putting money on that being right this time.

[Chewing Grass]

3 minutes ago, dgul said:

The saying is that silver is always late to the party.  

and first to leave...

[Castlevania]

22 hours ago, Democorruptcy said:

Can any of the option traders on here recommend a decent book on it?

The bible is John Hull’s Options, Futures & Other Derivatives. It’s very maths heavy and unless you want to work on an options trading desk probably way too detailed.

For a good high level overview that’s written in a nice simple style that I think most people would understand Michael Durbin’s All About Derivatives is highly recommended.