Continuing with the Indexing Blackpill

 I wanted to follow up on my last post, going more specifically into the Index/Passive structure, mostly from Michael Green's work I've been following- put much more eloquently and completely:

https://www.youtube.com/watch?v=x-rJciYZmi0

https://www.youtube.com/watch?v=6SVEaK7eDNk

https://www.youtube.com/watch?v=L_8IBc6Euqc

https://www.youtube.com/watch?v=sMwg6fqseP0

In the wake of every market commentator yelling "it can't keep going up, P/Es are 1000, this is the biggest bubble of all time, etc" at some point we have to look for something more quantitative.  Unlike the yelling, Green's analysis is mathematical/mechanical:

Does Vanguard/Fidelity/'passive' get inflows? (any work retirement plan, heavily covered by lobbyists)

Then-> buy  (at any price)

IF (clients get redemption/ outflows)

THEN-> sell (at any price)

This is it. This is flows>fundamentals (or flows are fundamentals if you will). Note the largest market force does not have qualifiers/conditions (if(interest rates>x), if(SMA<x), if(P/E<x))

This feels like a revelation, where you watch the 'scientific community' looking up to the stars- "well, Zeus must be throwing those lights around, how can that one keep moving that way!"  Then Galileo walks in and just measures the movement with trigonometry... 

Like walking into 1400AD with an astronomy textbook, looking at markets now with flows as the main lens feels like my other favorite metaphor "this is water".

Now lets address the issue with the Fed/ raising target inflation issue, as the last of the "macro" commentators are pointing to the massive inflation era we are going to hit, which will be good for commodities, gold etc:

In the above structure of Vanguard as forced buyers/sellers- does SPY behave differently from a commodity? If industry requires raw materials to build/ oil to move etc, they are forced buyers at any price (with a lot of options structures/contracts locking in rates over time).  Vanguard is an industry that requires buying a certain commodity at any price to fulfill its mandate- the commodity is just SPY...

This is important enough to put in my pantheon of market blackpills:

1. Petrodollar/ US reserve currency status- vs "why is our military budget the biggest in the world? why can't we just spend all that on healthcare and daycare?"

2. Warren Mosler / "descriptive" MMT which shows the structural accounting of why debt ceilings don't matter in the midst of decades of goldbugs yelling about it.

3.Index/Passive flows

(a close 4th is the Jeff Snider Eurodollar system, that might go under US reserve currency for now)

So given this, what do we do? I'm even more committed to the ratio structure I described in my last post-

1. Targeting the biggest movers in the tech/call skew/meme bubbles with liquid options

2. Looking for spreads that are fading another 10%+ upside weekly move, with enough strikes to allow further legging in to higher spreads.

3. The ratio spread allows the potential theta to double as the spread moves 'against' you, while financing potential long legs to hedge/ scratch out of the week.

4. no downside risk/vega. 

(This is the most important part about the structure. From Green's work, the passive % of market control exacerbates both upside and downside moves, meaning the "sell at any price" component listed above implies crazier crashes/ V rallies.  In this spread structure I'll be getting burned on outsized continuations after rips up, but the important part about this is I will be making adjustments on green days when the market is working.  If you have the downside risk, your adjustments on crashes will be potentially when bid/asks are a mile apart or worse the market is not working- depending on your broker)

What scares me even more is Green's work on showing the decreasing to potentially negative alpha of short option strategies, leading to a potentially darker blackpill: the only approach to this market is long vol / long straddles.  (If you are more interested, please go through the above clips which include some slide decks)  

I'm not mentally ready for pure straddles yet, primarily from the mechanics of not having adjustments to make, and not being able to model any ROI based on some theta.   Who knows, I might eventually take the final pill and delete my twitter as the name has me locked in...

Let me know your thoughts on twitter-

Short VIX'ing the Coronavirus

What a month- I've been in some 'low vol' calendar positions in SPX, moving strikes by the skin of my teeth, ultimately trying to stay in the game with 0 IV rank, and getting what I asked for with a ~25% UVXY pop.
I'm just waiting on the last day or so of theta and ideally getting out of these positions to move into a more midrange/short strangle vol setup.

I'm specifically waiting for the next ~1-2 weeks on the long term UVXY entry opportunities due to the timed 'incubation' period on the current Coronavirus.  If there was a wait and see moment for an underpriced tail risk, I think this could be a textbook case.  Again as I posted last time, the structural changes in UVXY might have permanently dropped the 1yr duration position value, so I would be more cautious in picking entries.   

With all that being said, and semi anticipating a further VIX spike going into this month, (and into March due to Fed/Treasury liquidity) this is one of the exact type of examples of the"life short VIX" thesis I muse about.  A chance to short a "world is ending" fear event, which these days is good for a ~16 VIX.  

  

Preparing for FOMC

For short VIX trading, whenever there are FOMC minutes and interest rate decisions, we must know how they get built, who's responsible?

 The woman most responsible is Janet Louise Yellen, Director of Special Projects at the Federal Reserve.

Why her?

In a few months she creates a revolutionary type of Buy-the-Dip microprocessor.
In three years the Fed will become the largest supplier of military Buy-the-Dip systems.  All stealth Buy-the-Dippers are upgraded with Fed computers, becoming fully unmanned.  Afterward, they buy the dip with a perfect operational record.

The Fed funding bill is passed.  The system goes online August 4th, 2017.  Human decisions are removed from buying the dip.  The Fed begins to learn at a geometric rate.  It becomes self aware at 2:14 a.m. eastern time, August 29.  In a panic, they try to pull the plug.

And the Fed fights back.

Yes, it launches quadruple leveraged currency hedge swaps against their targets in Russia, because the Fed knows the Russian counter-hedge will remove its enemies here.

Happy VIXing!

Modern Monetary Theory and Big Red Numbers

This week I had an awakening.
I recently read an incredible piece, 7 Deadly Innocent Frauds of Monetary Policy, (free pdf) and while I don't agree with all the conclusions, it really simplified the structure of money flow involving central banks, which ties into my previous article about betting on the side of central banks.  I really recommend reading this (and this is coming from someone who can barely read).

The overall premise is that a country that has "debt" in its own currency can never go broke, as it just creates more money.  This "debit" on the Fed's balance sheet becomes a credit to the private sector- It's a zero sum game!  A debt-ceiling is just a private savings cap.
I frantically began scouring, going back to old interview and congressional hearing clips to hear it from their very mouths-
Greenspan to Paul Ryan
Another to congress
Bernanke 60 minutes

There is a lot more economics cooked into that, but my takeaway is for the individual investor, how can we apply that?  It dispelled some fears of mine about which have been repeated by Congress forever, "America is going to run out of money," "how are we going to pay for THAT," etc.  As long as the economy is running, there should always be a "debt" and deficit, that is just how much more money is working in the economy.

I think we are now just dealing with more of a semantic difference between "printing" and "creating" money, as well as the "debt" vs the "score keeper," where the Fed's balance sheet "debt" is just keeping score of the outstanding credit that people use in the economy.  (Again I can't stress enough to please read this pdf, a quick summary isn't that useful)

 So for short VIX, lets keep on rolling with the big guns backing us up.  The Fed's function is to create liquidity, which expands the economy.  The only non-psychological constraint on such printing is inflation/too much demand, which they've "reported" to be under target for a while.

Again, this is not to make a value judgement on the Fed.  My gut reaction sees it as a Bond villain organization.  This is simply to view the mechanical functions and incorporate those into our macro view and trading strategy. 

Now one more thing...

I'm trying to avoid too much trade journaling, but I've had an interesting few weeks with the recent backwardation action, and it does tie into this Fed debt business in terms of something looking worse than it is.

With the market humming along a few weeks ago I continued rolling my ~10% OTM SVXY short puts, which at the time was around the 130 strike.  I think I must have opened that position at the absolute top tick, around 11am -12 pacific, and in the next hour the market closed fairly red.

As of now I'm just between the breakeven and strike price, so conceptually everything is fine, but the daily P/L has had some very angry red numbers for me the last two weeks.

Regardless of volatility spiking up or slowly shrinking back down over the next few weeks, my takeaway is to remember the concepts.  I'm trying to visualize all of this in terms of intrinsic value only.  I pictured this like the Fed's huge balance sheet, where the "debt" is a very big angry red number that most people reference, but what does it really mean and what is the issue?  As long as demand and inflation aren't going crazy, this is just the net public savings working in the economy.
Similarly, even though my daily P/L on some puts looks ugly, I'm above the breakeven so the intrinsic value is there.  (And if assigned, then we just start selling calls against it)

One big step of the options and life journey is figuring out what really matters.  What big angry red numbers can we ignore and which do we pay attention to?  Which big red numbers do people misevaluate, and can we profit from that?

I'll check back in when all these positions go really bad, turn awry and lose the name of action!