Observations & Insight

An article that hits the bull’s-eye
Doug Ashburn – John Lothian News

Jared Dillian is the author of Bull’s-Eye Investor and the 10th Man, two publications of Mauldin Economics. I have followed Mauldin Economics and its founder, John Mauldin, since he began publishing his free weekly newsletter over 15 years ago. Though the firm has branched out considerably since then, into (often steep) subscription-based newsletters, I still read a couple of the free weekly offerings, including those of Mr. Dillian.

I have been waiting for an opportunity to feature one in JLN Options. Since his latest column is options-based, today is the day.

The article begins with a basic overview of options theory and delta-neutral strategies, in order to help those unfamiliar with options to understand his main point, which is that there is a danger lurking in this market, a danger he has labeled “covert gamma.”

He begins with a history lesson from 1987 on portfolio insurance, that once-popular strategy
of “hedging” a portfolio by pretending to have a short gamma position that needed to be hedged dynamically. It worked fine until that fateful day in October 1987 when everyone needed to hedge at once, and the hedges set off additional trigger points that needed to be dynamically hedged.

Dillian argues that today’s “buy-the-dip” strategy, combined with a modern market structure that allows all participants immediate access from any spot in the world, has created an environment ripe for disruption.

I won’t spoil the punch line. Click over and read it for yourself. Tell him Doug sent you.

Lead Stories

China Stock Meltdown and Inside Information
By Steven M. Sears – Barron’s
Some investors apparently had inside information about China’s brokerage firms preparing to clamp down on margin accounts. That crackdown was credited with helping torpedo Chinese stocks Thursday.
These investors pre-positioned for Shanghai’s stock market to decline by buying bearish put options on a major U.S. exchange-traded fund that tracks China’s stock market.

***DA: It’s good to be the king, or at least to be someone really close to him.

Checking Up On the VIX-Product Rookies
By Adam Warner – Schaeffer’s Research
It’s a week and a half or so into the life of AccuShares Spot CBOE VIX Fund Up Shares (VXUP) and AccuShares Spot CBOE VIX Fund Down Shares (VXDN), so it’s high time to make some snap judgments!

***DA: My snap judgment? After the snap, punt.

Five Options Trading Myths Exposed
By Jacob Mintz – www.cabot.net
Shortly after I graduated, I reconnected at a Chicago restaurant with about 10 of my former college friends. We were all catching up and talking about what we were now doing for a living. When it came to my turn, I told the group that I was a trader on the floor of the Chicago Board of Options Exchange, which was met with blank stares and silence. Their clear lack of understanding of what that meant was surprising to me because all these friends had just graduated with business degrees. One member of the party said with confidence, “Oh, so you basically gamble all day.”

***DA: For the 20 years I worked as an options market maker I got that question a lot. I always said I was more akin to the casino – the entity that allows others to have an orderly market when they invest (and gamble at times), in exchange for a theoretical mathematical advantage.

There’s a Lot Going On Below the Surface of This Quiet Credit Index
By Tracy Alloway – Bloomberg
Trading Markit’s CDX index has become a go-to strategy for big investors who want to take a position on corporate bonds. The CDX.NA.HY, for instance, offers investors the ability to trade a basket of credit default swaps (CDS) offering protection on a bunch of junk-rated U.S. corporate debt. With low levels of liquidity in the cash bond market, trading CDS protection through the CDX can be an easier and cheaper way to go long or short corporate credit than actually buying or selling the debt.

We Finally Found a Use for VXX
By Adam Warner – Schaeffer’s Research
We saw a huge CBOE Volatility Index (VIX) surge yesterday morning. Our favorite fear-and-greed proxy jumped 15% out of the gate, which — I will admit — is pretty noteworthy no matter when it happens. It’s especially interesting given that while the market was weak, it was far from an implosion. We dropped about 0.6% in the early trade.


CBOE Wins Global Capital’s Derivatives Exchange of the Year – Americas’ Award
Press Release
The Chicago Board Options Exchange (CBOE) was named “Derivatives Exchange of the Year — Americas” Thursday night at GlobalCapital’s (www.globalcapital.com) Americas Derivatives Awards 2015 ceremony in New York City.
According to the GlobalCapital Derivatives editorial team, “CBOE was chosen as this year’s exchange of the year in our Americas Derivatives Awards because of its commitment to client service through its extended trading hours initiative, its work on regulatory issues, the breadth of the range of its index products, and its commitment to developing new ones as the derivatives market evolves.”

***DA: No argument there.

Derivatives: Introduction of Weekly options on Norwegian shares on June 8th
Press Release
NASDAQ OMX Derivatives Markets will introduce weekly options on Norwegian shares. The launch date for introduction of weekly options on Norwegian shares in production is set to Monday June 8th, 2015, and the product is available for member testing in external test systems 1 as of Monday June 1 and in external test systems 3 as of Tuesday June 2.

***DA: A week, which, according to our former COO Jon Matte, is about how long summer lasts in Norway.

NYSE Looks to Ease Late-Day Pileup; Exchange plans midday auction for thinly traded shares
By Dan Strumpf and Corrie Driebusch – WSJ
The New York Stock Exchange is preparing a new plan to make it easier to buy or sell the shares of thousands of listed companies, an effort to counter the slow midday trading and uneven liquidity plaguing U.S. stock markets.
***DA: Not much you can do, though, about the fact that a good number of participants want to be filled at or near the closing print.

OCC Appoints Joseph Kamnik as General Counsel
Press Release
OCC, the world’s largest equity derivatives clearing organization, announced today that Joseph Kamnik, currently the firm’s Vice President and Chief Regulatory Counsel, has been promoted to Senior Vice President and General Counsel, effective June 1. Kamnik will oversee OCC’s legal and regulatory affairs, and provide counsel on a broad range of legal matters to OCC’s management and board of directors. He will report to Craig Donohue, Executive Chairman.

Former U.S. House Speaker Hastert quits CME Group board
By Tom Polansek – Reuters
Former U.S. House of Representatives Speaker Dennis Hastert resigned from the board of exchange-operator CME Group Inc on Thursday, the company said.

Regulation & Enforcement

EU Targets April for Interest-Rate Derivatives Rules
By Ben Moshinsky – Bloomberg
The European Union may implement clearing rules for over-the-counter interest-rate derivatives as early as April next year, said Jonathan Hill, the 28-nation bloc’s financial-services chief.
The European Commission has finished talks with the European Securities and Markets Authority and is “starting the process of getting the first clearing obligations adopted,” Hill said in Brussels on May 29.

ASIC consults on central clearing obligations for OTC derivatives
By Mike Fox – LeapRate
The Australian Securities & Investments Commission (ASIC) today proposed draft rules to implement mandatory central clearing requirements (clearing requirements) for certain over-the-counter (OTC) derivatives. The proposals are the next stage in Australia meeting its Group of Twenty (G20) commitments to reform OTC derivatives markets following the global financial crisis (GFC).
The binary option instrument could get a look here as many Aussie based brokerages have pulled their binary option offerings in the last year as they await more clarification on regulation of these options which have become popular within the retail trading sector.

ASC Investor Alert: Unregistered binary option platforms target Edmonton area
Press Release
The Alberta Securities Commission (ASC) is warning Alberta investors of several unregistered binary option companies promoting online trading platforms (via their websites) that are currently soliciting Albertans, specifically in Edmonton and surrounding areas.

Judge Gets Letter Demanding Flash-Crash Case Be Dropped Against U.K. Trader
By Margot Patrick – WSJ
A plea to an Illinois judge to stop the case against British trader Navinder Singh Sarao, or else “bear the liability of all wrongs,” has been entered into official court proceedings.
The letter, addressed to U.S. District Court for the Northern District of Illinois judge Andrea Wood, was added to the publicly accessible case docket on May 18 as a “statement by Navinder Singh Sarao.” That characterization, however, was immediately disputed by Mr. Sarao’s lawyers at Kobre & Kim LLP, who said Mr. Sarao didn’t write or authorize the document.


Glaxo Bulls Awaken With Calls as Pfizer Merger Chatter Escalates
By Sofia Horta E Costa – Bloomberg
Options traders are getting busy with a U.K. stock they have rarely paid attention to.
Volume in GlaxoSmithKline Plc contracts surged to the highest level since 2007 this month, with traders paying record prices for bullish options relative to bearish ones. All that after the stock lost $11 billion in value over two months.
Options have become the tool of choice for speculators as analysts flagged the company as a potential acquisition for Pfizer Inc. As deal chatter increases, so does optimism that Glaxo will give in to pressure to shake up management.


How To Sniff Out The Options Opportunity Under Your Nose
By David Settle – Benzinga
Looking for trade ideas can be time-consuming for option traders. With so many optionable stocks available, you can spend hours trying to find the right match for your investing objectives. In fact, too much window shopping may make it hard to take the plunge.
Good news: there are indicators that can aid your search. Among them is volume. It’s already an important statistic in stocks, but can be especially telling when trading options. By sniffing out unusual options activity with higher-than-normal volume, you may be able to find trading opportunities. Here’s how.

Why VXX Loses Value Over Time: Another Look
By David Easter – Seeking Alpha
iPath S&P 500 VIX ST Futures ETN (NYSEARCA:VXX) began trading on January 30, 2009, at a split adjusted price of 6690.98. It closed on May 18, 2015, at 19.42. Since inception, the share price has decreased to 0.29% of its original value over 6.3 years, consistent with an average annual loss of -60.5%. This is in the same ballpark as the 5-year average annual losses of -56.22% and -59.86% posted on Yahoo Finance and Morningstar, respectively.
In this article, “day” normally refers to a trading (not calendar) day, and the analysis considered data up through Friday, May 22, 2015, unless specified otherwise. The word, “price” will sometimes be omitted in the text, but implied when appropriate within the context: For example, F1 should be interpreted as the price of F1 VIX futures, when the context warrants. For this study, historical VXX data were taken from Yahoo; VIX, F1, and F2 data through May 8, 2015, were taken from here; and the most recent VIX, F1 and F2 data were recorded by hand from the CBOE Web Site. The VXX prospectus documents the details of how the ETN works. The methodology underlying the S&P 500 VIX Short-Term Futures Index (SPVXSTR), which VXX tracks, can be found here.

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