JLN Options: How Scared Should Investors Be of October?; Time for insurance on an 'unsustainable' market?; Bank derivatives boom ahead of ECB test results as investors play safe

Oct 7, 2014

Observations and Insight

The New Frontier: Born Technology’s Haworth Says Price Now Matters in Technology and HFT

Today’s markets are often touted as “all about speed”, but that reach for low latency is only part of a successful strategy. Derek Haworth, president of Born Technology Solutions says that more firms are looking to cut costs on technology, such as exchange connectivity and order book solutions. For his clients, its about finding the balance between financial technology and expenses.

“What we’ve been seeing over the course of the past year, year and a half, is that people are moving toward what I would call smart latency,” Haworth said, “where there is an understanding that spending an extra $100,000 to shave off another 200 nano-seconds isn’t really commercially or economically feasible. So we’re seeing the pendulum swing a little away from the lowest latency trade.”

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Lead Stories

How Scared Should Investors Be of October?
Chana R. Schoenberger – WSJ
It’s October, when some investors and analysts worry about the stock market’s ghosts. There are good reasons for that fear, but also evidence that the month typically is only as frightening as your neighbor’s child in a devil costume.
First, the scary part: Some of the market’s most harrowing declines have happened in October, including the 1927 and 1987 crashes and several of 2008’s financial-crisis tumbles. And even when there aren’t crashes, the month can be volatile, as measured by the options market.
***DA: If you are a believer in this bull market, October should be your favorite month of the year, as it gives you a nice buying opportunity.
***SR: Also, buy candy.

Time for insurance on an ‘unsustainable’ market?
Lawrence Delevingne – CNBC
Stocks have gone virtually straight up for more than five years. Interest rates are poised to rise. Volatility-a gauge of fear in the marketplace-barely registers. Every time the market swoons, like it did as October began, it snap backs as bullish traders “buy the dip,” as Wall Street calls it.
Some say investors are following former Citigroup (NYSE:C) CEO Chuck Prince’s ill-fated advice from 2007. “As long as the music is playing,” he said at the time, “you’ve got to get up and dance.”
Prognosticators like Mark Spitznagel think that music is about to end.

Bank derivatives boom ahead of ECB test results as investors play safe
Business Recorder
Investors hopeful but not entirely confident that next month’s European bank check will yield positive results are stacking up derivatives positions to balance optimism about the industry against worry over its performance in a faltering economy.
The European Central Bank is expected to publish the outcome of its bank asset quality review on October 26 in a bid to convince investors – after three previous “stress tests” failed to spot subsequent problems – that Europe’s lenders have sifted out their risky holdings and now have enough capital to withstand any more financial crisis-style shocks.
***DA: Whew. I feel so much safer now. How about you?

Record 200-day moving average due for a fall
Lawrence G. McMillan – MarketWatch
The decline in the S&P 500 index SPX, accelerated after breaking through minor support at 1,965 last week. But in reality, the index has been declining since making a new all-time intraday high on Sept. 19 — the day of the Alibaba BABA, initial public offering. That is not a coincidence.
***DA: So Jack Ma got out at the top?

Stock Market VIX Voodoo Analysis
Austin Galt – The Market Oracle
The Volatility Index (VIX) seems to be indicating something big is brewing. Let’s investigate taking a bottom up approach beginning with the daily chart.Since the low back in July 2014, price has developed a pattern of higher highs and higher lows – a bull trend. The Stochastic and Moving Average Convergence Divergence (MACD) indicators have just turned bearish so perhaps price is now headed down to put in yet another higher low. Where is this next low likely to be?

WTI Closes at 17-Month Low on Supply Outlook; Brent Drops
Moming Zhou – BloombergBusinessweek
West Texas Intermediate crude ended at a 17-month low before a government report that may show U.S. inventories increased last week. WTI’s discount to Brent widened.
U.S. crude inventories expanded by 2 million barrels in the week ended Oct. 3, a Bloomberg News survey showed before Energy Information Administration data tomorrow. The EIA cut its crude price forecasts today in a monthly report because of rising output and reduced demand. The Brent-WTI spread rose above $3 for the first time in four days.

Spot iron ore price decline fuelled record derivatives volume – Metals
Platts News
Slumping iron ore prices in September caused derivatives volumes to spike, after a relative sanguine period with prices hovering in a narrow range, according to data from The Steel Index.
Over 62 million mt of iron ore derivatives were cleared outside China last month, with 15.6 million mt of options trade, 25 million mt of futures and the balance swaps.
***DA: Slack demand in two major inputs – oil and iron. Leading indicators of weakness on the horizon.

Time to focus on Chinese derivatives
William Barkshire – Financial Times
There have been many false dawns in the progress to open up China’s participation in global capital markets.
That has led to the loss of interest by some overseas investors and in some cases retrenchment. However, under Xi Jinping’s leadership market liberalisation is now gathering a real pace and international players should start paying more attention to concrete evidence of development.
***DA: Global financial centers are issuing RMB-backed bonds, and offshore RMB currency pairs are seeing healthy gains. Options are once again legal in China. The trends are positive.


Bats Chi-X hikes data fees
Tim Cave – Financial News
The London-based trading platform will increase charges for most elements of its market data by 5% from January 1, 2015, according to a price list distributed to members on Monday.
It is the first time Bats has increased its fees since it began charging for its data in October 2012. However, since then the platform has doubled the number of securities it trades, grown its market share to around 22% of all European trading and added a new industry standard to its data, called MMT.

Euronext opens equity options markets to US investors
FTSE Global Markets
European stock market operator Euronext will begin to offer Dutch and Belgian equity options to certain eligible US investors after receiving approval from the Securities and Exchange Commission (SEC).

TASE Launches Options and Futures on TA-100 Index
Press Release (via MarketWatch)
The Tel Aviv Stock Exchange (TASE) Board of Directors approved the launch of derivatives (options and futures) on the TA-100 index. The new derivatives join existing products on a number of underlying assets – the TA-25 index, the TA-Banks index, the ILS/USD exchange rate, the ILS/Euro exchange rate, and 10 individual stocks included in the TA-100 index.

Regulation and Enforcement

‘Spoofing,’ a New Crime With a Catchy Name
Peter J. Henning – Dealbook – NY Times
Giving a crime a catchy moniker is a good way to get attention when prosecutors pursue a new form of misconduct. There is, for instance, a type of money laundering called “smurfing,” named for the cute blue cartoon characters, that involves runners for a drug organization making small cash deposits at various banks to avoid the currency transaction reporting rules.
***JL: The criminalization of market activity will have a very chilling effect on our capital and commodity markets. It will have a disastrous impact on the reliability of price discovery and will lead to even bigger shocks and crises in the markets in the future. But hey, now the regulators can say they did something.

Expand Automated Trading Safeguards to Include Brokerages, SEC Members Say
Dave Michaels – Bloomberg
U.S. rules meant to guard against breakdowns in automated trading systems should be expanded to include brokerages that match orders away from regulated stock exchanges, two Securities and Exchange Commission members say.
Luis A. Aguilar and Kara M. Stein, both Democrats, have called on SEC Chair Mary Jo White to apply the new requirements to wholesalers such as Citadel Securities LLC and KCG Holdings Inc. (KCG), which collectively execute as much as 19 percent of shares traded. Brokerages have lobbied to stay outside the reach of the Regulation SCI measures, saying failure of any one broker’s systems won’t disrupt trading beyond its own platforms.


Do You Have the Stomach to Sell Volatility?
Adam Warner – Schaeffer’s Investment Research
We often mention that the anticipation of future volatility tends to outstrip the reality of actual volatility. Implied volatility proxied by the CBOE Volatility Index (VIX) averages about a 4-point premium to realized volatility. VIX futures almost permanently slope upward, and ultimately almost always anticipate a permanent volatility lift that rarely takes place. Go to different asset classes and use different proxies, and the results are almost always the same.
So, should you attempt to capitalize on this perpetual disparity?

Options Education

Do Options Dream of Dancing Underliers?
Vance Harwood – CBOE Options Hub
While doing simulations on volatility and the square root of time I started thinking about what kind of time options experience—calendar time, market time, or something in-between. The CBOE’s VIX calculations use calendar time, a 365 day year, but most option gurus recommend using a 252 day year for volatility calculations—the typical number of trading days per year in the USA markets.
When it comes to option decay most people, including the gurus, believe that option values decay when the markets are closed—a position I believe conflicts with the 252 day approach to annualizing volatility.

How Do Options Experience Time?
Vance Harwood – Investing.com
While doing simulations on volatility and the square root of time I started thinking about how options experience time—is it calendar time, market time, or something in-between?  The CBOE’s VIX calculations use calendar time, a 365 day year, but most option gurus recommend using a 252 day year for volatility calculations—the typical number of trading days per year in the USA markets.
When it comes to option decay most people, including the gurus, believe that option values decay when the markets are closed—a position I believe conflicts with the 252 day approach to annualizing volatility.

How To Know How Far A Market Will Move
Darrell Martin – Benzinga
To better understand Expected Movement and Deviation Levels, suppose for a moment that you are an Auto Insurer. You have a 40-year-old woman with no accidents and a 16-year-old boy who has already totaled his first car and wants to insure his next car. Who is going to pay the most in premium? How much risk is involved in insuring each of these people? These things are taken into consideration when the price of the premium of the insurance is determined. Likewise, the amount of risk and the expected movement is built into the price of an option.

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